The deductibility of advertising expenditure was questioned in the case of The Crown and Cushion Hotel (Chipping Norton) Limited v HMRC [2016] UKFTT 765 where a company made payments towards sponsoring the director’s daughter’s motor racing career.

The taxpayer operated a family owned hotel business established by Mr Jim Fraser. The taxpayer was owned by Mr Fraser’s 2 daughters, Mrs Powell (who was also the sole director) and her sister. However, Mr Fraser remained the key decision maker of the company. Each of the six hotels owned by the taxpayer was run by a manager under an incentive scheme whereby the manager is able to benefit from the profits generated by the particular hotel he manages. A portion of the hotel’s profits is paid to the manager while the balance is paid to the taxpayer as “rent”.

A recession in 2008 had a significant adverse impact on the business of the hotels and the taxpayer agreed to reduce the managers’ “rents” on a temporary basis. Mr Fraser then decided to advertise the hotels by sponsoring his granddaughter, Miss Powell, who was an up and coming motor racing driver. His aim was to improve the business of the hotels such that the managers would be able to make their full “rent” despite the effects of the recession.

Under the 2008 agreement with Miss Powell, (i) the taxpayer would sponsor £160,000 plus VAT annually for Miss Powell in the following four years, (ii) Miss Powell would give the taxpayer 15% of her racing earnings for the next 12 years and (iii) Miss Powell would undertake advertising, promotional and sponsorship obligations such as carrying advertising decals to promote the taxpayer’s hotels, attending product launches and promoting the taxpayer’s products. There was also a penalty clause inserted in the event of Miss Powell breaching the agreement where she had to refund all the monies paid by the taxpayer in addition to a 50% penalty for all such monies that were spent by the taxpayer on Miss Powell. Miss Powell would still be contracted to pay 15% of her competitive earnings to the taxpayer through the contracted 12 year period. Mrs Powell (Miss Powell’s mother) was not in favour of this agreement.

The issue was whether the payments made under the 2008 agreement were incurred wholly and exclusively for the purposes of the taxpayer’s trade and hence deductible against its income.

The First Tier Tribunal held that the word “exclusively” means that if the expense was also incurred for some other non-trading purpose, it is not deductible. As per Vodafone Cellular v Shaw [1997] STC 734, this involves an inquiry into the taxpayer’s subjective intentions at the time of payment. In addition, the object of the taxpayer must be distinguished from the effect of payment. The payment can be made “exclusively” for a trading purpose even if there are other consequences that are merely incidental to the purpose of the payment.

The Tribunal held that the taxpayer’s object in making the relevant payments was solely to promote its business. The benefit to Miss Powell in receiving the sponsorship or to the managers as a result of any increase in profits due to advertising was in each case an incidental effect of the payments.

The Tribunal placed weight on the fact that the advertising through Miss Powell could materially assist the business through the recession in 2008. The hotels were situated close to motor racing tracks and the bases of motor racing teams. It was thus credible that Mr Fraser thought that advertising within the motor sports sector could bring further guests to the hotels both from members of the public who attend races and those involved in the racing industry. Given Miss Powell’s media profile and potential as a racing driver at that time, it was also credible for Mr Fraser to regard Miss Powell as a valuable commodity to his business. The taxpayer’s profits at 2011 also supported this as they had improved as compared to 2008.

The 2008 agreement was also drafted by Mr Fraser with the taxpayer’s position in mind. The court focused on the requirement for Miss Powell to pay a percentage of her earnings to the taxpayer over a 12 year period and the punitive penalty provision in the event of Miss Powell’s breach to reach this finding. Miss Powell had also wanted to terminate the 2008 agreement in 2011 while Mr Fraser did not want to. This, along with Mrs Powell’s unhappiness at the agreement, supports the conclusion that the purpose of the agreement was for the taxpayer’s business rather than for Miss Powell’s benefit.

As such, the sponsorship expenditure was found to be made wholly and exclusively for the taxpayer’s business and a tax deduction was allowed.

Editorial Note

This case applies the settled principle that the subjective intention of a taxpayer is important in determining whether an expense is wholly and exclusively incurred in the production of income. It should however be noted that the effect of the expenditure is not usually relevant to the issue.