Lady Rose and Lord Doherty gave judgment, with which Lord Reed, Lord Stephens and Lady Simler agreed. The appeal was from the Court of Appeal’s decision in [2025] EWCA Civ 3, which had found all the payments deductible. The court’s press summary gives the background.
The facts
ScottishPower Energy Retail Limited (SPERL) held gas and electricity supply licences; the other three respondents held electricity generation licences [2]. The Gas and Electricity Markets Authority (GEMA) and the Office of Gas and Electricity Markets (Ofgem), which carries out GEMA’s day to day work, conducted four investigations. Ofgem found that SPERL had committed serious breaches of several licence conditions and of the Electricity and Gas (Community Energy Savings Programme) Order 2009 [2].
GEMA initially told SPERL that it intended to impose fines under its penalty powers in section 27A of the Electricity Act 1989 and the corresponding provision of the Gas Act 1986 [3]. Instead, each investigation ended in a settlement under which payments were made to customers or charities and GEMA imposed a £1 penalty:
| Investigation | Settlement date | Payments agreed | Penalty |
|---|---|---|---|
| Mis-selling and marketing (SLC 25) | 10 October 2013 [23] | £7.5 million to vulnerable customers and £1 million set aside for compensation to customers affected by mis-selling | £1 |
| Costs reflectivity (SLC 27.2A) | 15 May 2014 [28] | £750,000 to Energy Best Deal Extra | £1 |
| Community Energy Saving Programme Order | 4 December 2014 [33] | £2.4 million to ScottishPower Energy People Trust | £1 |
| Complaints handling | 25 April 2016 [37] | £18 million of consumer redress payments | £1 |
Before settlement, there were indications of the penalties that would be sought if the cases were contested: in the costs reflectivity case, an internal ScottishPower email of 11 March 2014 recorded that if the case were contested “they would be looking for a fine of £2.5m” [27]; Ofgem referred to a penalty of £3,600,000 in the energy saving case [32]; and in the complaints handling case Ofgem mentioned an initial penalty figure of £23 million, discounted to £18 million for early settlement [36].
It was common ground that a £28 million fine would not have been deductible; ScottishPower argued that the payments were not penalties and were deductible [3].
The issue
The court framed the issue as “why penalties imposed on a taxpayer are not deductible expenses when computing trading profits; and whether the Redress Payments should also not be deductible” [4].
Under the Corporation Tax Act 2009 (CTA 2009), section 46(1) requires trading profits to be calculated in accordance with generally accepted accounting practice, “subject to any adjustment required or authorised by law in calculating profits for corporation tax purposes” [5]. Section 54(1)(a) provides that no deduction is allowed for “expenses not incurred wholly and exclusively for the purposes of the trade” [5].
The decisions below
The First-tier Tribunal allowed only £554,013 paid to customers affected by mis-selling, which it treated as compensatory [69], [70]. The Upper Tribunal allowed HMRC’s appeal on that sum and held that none of the payments was deductible, because they were “part of an overall package” made in place of penalties [73], [74].
The Court of Appeal (Falk LJ, with whom Snowden and Zacaroli LJJ agreed) allowed ScottishPower’s appeal [75]. It treated the rule against deducting penalties as a judge-made adjustment under section 46(1) [77], and held that extending it to payments which are not in fact penalties could go beyond the proper role of the judiciary and would be a matter for Parliament [78].
The decision
The Supreme Court allowed HMRC’s appeal and restored the decision of the Upper Tribunal [100]. None of the Redress Payments, including the £554,013, is deductible [99].
The reasoning
Why penalties are not deductible
The court said: “It is clear on the authorities that penalties are not deductible. In our view it is also clear that the reason they are not deductible is that they are not incurred for the purposes of the trade” [81]. Penalties “are punishments imposed because of wrongs which the taxpayer has committed”, and “The taxpayer’s object in paying the penalty is not to carry on the trade, but to answer for his breach” [81].
The court traced that reasoning to the Court of Appeal’s 1920 decision in Inland Revenue Commissioners v Alexander von Glehn & Co Ltd, in which all three judges accepted that a penalty paid in the course of the trade was not, for that reason alone, paid for the purpose of the trade [82]. It held that McKnight v Sheppard (1999) 71 TC 419 “confirms that it is the nature of penalties which results in expenditure to meet them not being for the purposes of the trade”, as a matter of construction of what is now section 54(1)(a) [83].
Lord Hoffmann’s reference in McKnight to legislative policy being “diluted” had led the Court of Appeal to identify a separate judge-made rule. The Supreme Court said that “was a misreading of Lord Hoffmann’s reasoning”, and that “He was not introducing or relying upon any policy-based, judge-made rule” [85]. The taxpayer’s purpose in paying a penalty “is to satisfy a legal obligation which arises usually under statute to punish the taxpayer for infringing rules which bind him in the conduct of his trade”, and on the true construction of section 54(1)(a) that “is not a purpose of the trade” [86].
Policy reasons support that construction, the court added; it rejected Falk LJ’s suggestion that a regulator could gross up a redress payment to offset a more favourable tax treatment [87].
Why the Redress Payments are treated as penalties
The court did not accept ScottishPower’s description of the payments as voluntary. SPERL was not compelled to settle, “But it is also clear that if it had not done so, it would have faced fines of the same or similar amounts” [89]. It relied on the First-tier Tribunal’s finding that the settlements were “made in place of what might have been imposed” [89].
Treating the payments differently from penalties would produce what the court called a “counterintuitive result”: a regulated person with a clear breach is more likely to settle quickly and deduct the payment, while one with a more borderline case may prefer to force GEMA to impose an appealable penalty that would not be deductible [90]. The payments were assessed “as a matter of substance rather than form” [90].
It also rejected the argument that the payments were like compensation for breach of contract, the contract being the supply licence. The energy saving breach was of a statutory instrument, not a licence condition [92], and the licence conditions “are not, in our judgment, like a contract, they are more like a statutory obligation” [93]. GEMA’s published decision notices established “the direct link between the Redress Payments and the penalty that would have been imposed” [93].
The court concluded that the payments “are sufficiently akin to penalties” that they were not incurred for the purposes of the trade under section 54(1)(a) [94]. It made no difference that the money went to recipients selected by GEMA rather than to the Consolidated Fund, or that the payments would be expenses under generally accepted accounting practice [94].
On the £554,013, the court agreed with the Upper Tribunal that it “was not, in our judgment, akin to damages for breach of a tortious obligation but was as much a punishment for breaches of the conditions as the other sums” and was part of a package negotiated as an overall deal [99].
The court held that Herald and Weekly Times v Federal Commission of Taxation (1932), an Australian libel damages case relied on by ScottishPower, “has no place in assessing whether penalties or redress payments are tax deductible” [97].
What it changes for practitioners
The court has stated that the non-deductibility of penalties rests on section 54(1)(a) CTA 2009, not on a judge-made adjustment under section 46(1): penalties are not incurred “for the purposes of the trade” [81], [83], [85]. The Court of Appeal’s contrary analysis, that there was a policy-based, judge-made rule which applied even where payments were made for the purposes of the trade, was described as a misreading of McKnight [85].
Payments made under a regulatory settlement in place of a penalty can be “akin to penalties” and therefore non-deductible, assessed “as a matter of substance rather than form” [90], [94]. On the facts, that applied to the whole package, including amounts paid to customers directly affected by the breaches [99].
The court identified several matters it was not deciding:
- Its consideration of McKnight extended only to why penalties are not deductible; whether legal fees or other expenses of resisting disciplinary proceedings are deductible “is not raised in the present appeal” [80].
- Having found the payments were not for the purposes of the trade, it did not need to consider duality of purpose [98].
- It accepted that “There may be cases where there is a difficult dividing line to draw between sums expended at the close of the investigation and sums expended to pre-empt or appease the regulator at an earlier stage”, said HMRC will make its own assessment in such cases with any challenge determined by the tribunal, and said this case was not one of them [95].