Can the Post Office deduct compensation payments?

Tax blogger Dan Neidle has recently turned his hand to creating (well deserved) headaches for the Post Office. The tax nugget that he has apparently unearthed this time relates to the question of the tax deductibility of a provision for compensation payments.

The issue

The compensation in question broadly relates to the suffering and loss of livelihood experienced by many sub-postmasters across the UK.

There are two technical points to consider here:

• Was a provision correctly made?
• Tax deductibility of compensation payments

We explore each of these in turn below...

Was a provision correctly made?

This is primarily an accounting question and if a provision is in breach of accounting rules then it would follow that there would be no tax relief. The key conditions which need to be satisfied are as follows:

• The company has an obligation to pay a cost, which has been established by the reporting date for the accounts, and arises due to a past event; and
• It is probable (i.e. more likely than not) that the company will be required to pay that cost; and
• The amount of the cost can be reliably estimated.

Given all of the furore around the injustice suffered by the sub-postmasters, let’s assume that the provision was correctly made (and presumably it would not have got through the audit if it wasn’t).

The next question revolves around deductibility...

Tax deductibility of compensation payments

Neidle is suggesting that the compensation payments should not be deductible on the basis that the expenditure was not incurred wholly and exclusively for the purposes of the trade. He is suggesting that the compensation may not have been wholly and exclusively for the purposes of the trade on the basis that they were made as compensation for illegal activity.

Whilst this is a tenable position and works on a similar rationale to having to disallow parking fines, the position may not be completely cut and dry.

HMRC say in BIM38510 that, as a general rule, ‘damages incurred as a result of normal trading operations are allowable. Penalties for infraction of the law are not’. HMRC goes on to say that ‘you should allow a trader the costs of civil damages for injury to others caused by day to day trading operations. You should disallow any penalty for infraction of the law’.

From the above, the deductibility of the compensation payments may ultimately hinge around whether they are seen to be caused by a glitch in the Horizon software that the Post Office took on in good faith, or fraudulent activity in taking action against sub-post masters. I know what Mr Bates would say!

Hamilton Rose's view

Compensation payments to employees and customers can be a tricky area when deciding whether a tax deduction is due. The lines are blurry but, generally, damages resulting from events in the normal course of trade (e.g. a post man gets hit with a parcel coming out of a chute) should be allowable, but damages for illegal actions will not be (asbestos damage when the asbestos should have been removed).

It will be interesting to see how HMRC determines the post office case as apparently it is under enquiry…