Energy: Supreme Court to decide tax deductibility of payments made to consumers/consumer organisations in settlement of regulatory investigations

In Scottish Power (SCPL) & Ors v HMRC [2025] EWCA Civ 3, the Court of Appeal decided that payments made by ScottishPower (SCPL) Limited and others (collectively referred to as “ScottishPower”) in settlement of regulatory investigations were not penalties and therefore were deductible for tax purposes. The decision has important implications for the heavily regulated energy sector, and permission to appeal to the Supreme Court has now been granted. 

Facts

Between October 2013 and April 2016, ScottishPower entered into various settlement agreements with the Gas and Electricity Markets Authority (“GEMA”), operationally managed by Ofgem, to resolve investigations into certain regulatory issues. These settlements involved payments to customers, charities and a consumer organisation totalling around £28 million, alongside nominal penalties of £1.  

ScottishPower sought to include such payments as deductible expenses for the purposes of calculating its profits that were subject to corporation tax. HMRC denied deductions for these payments on the basis the payments were penalties (which are not a deductible expense for tax purposes), leading ScottishPower to appeal HMRC’s decision.

The First-Tier Tribunal (“FTT”) largely agreed with HMRC, only allowing deductions for a small portion which it deemed to be compensatory and wholly and exclusively for the purposes of the trade. Its position was that payments made in lieu of a penalty were not deductible, while compensatory payments are deductible.

Both parties appealed to the Upper Tribunal (“UT”), which upheld HMRC’s original position that all payments were non-deductible as they were in the nature of penalties. ScottishPower appealed the UT’s decision.

Decision

The central issue for the Court of Appeal to determine was whether the payments made under these settlement agreements can be classified as penalties and thus non-deductible. In deciding that the payments were deductible the following points were considered:

1. The regulatory context: The Court of Appeal reviewed the regulatory framework, noting that GEMA’s power to impose penalties is distinct from its ability to agree on settlements involving payments to consumers. GEMA has no power to redirect penalty payments to consumers (penalties being required to be paid into the Consolidated Fund). The payments made, along with other factors such as ScottishPower’s willingness to improve customer services, were taken into account by GEMA when deciding to impose a nominal penalty. It was clear that GEMA did not consider the settlement payments to be penalties.
    
2. The nature of the payments: It is a long-standing principle that penalties are non-deductible for tax purposes, since allowing deductions for penalties would dilute the legislative policy behind making penalties by allowing the taxpayer to share the burden with the rest of the community. This is known as the von Glehn principle, following the case of Commissioners of Inland Revenue v Alexander von Glehn & Co [1920] 2 KB 553and as subsequently clarified by Lord Hoffman in McKnight (HM Inspector of Taxes) v Sheppard [1999] 1 WLR 1333. Here the payments were not penalties, but were made under settlement agreements in order to avoid penalties. The only penalties actually imposed were nominal £1 amounts.
    
3. Scope of non-deductibility: The Court of Appeal therefore considered whether the rule against deducting penalties could (or should) be extended to payments replacing penalties, as argued by HMRC. In deciding that the rule could and should not be extended the Court of Appeal decided:  “In short, there is no need for judges to step in to ensure that differences in tax treatment between penalties or fines and alternative forms of redress are avoided. The policy imperative for a rule that would deny a deduction for amounts that are not in fact penalties or fines is simply not there. Further, I cannot see that it would properly be a matter for the courts, rather than Parliament, to develop such a rule. The principle established by von Glehn is clear and obviously correct for the reason explained by Lord Hoffmann in McKnight v Sheppard, but its proper limits need to be observed”.
    
4. The purpose of the settlement payments: The FTT had found that the payments were deducted were a legitimate business purpose and made wholly and exclusively for the purpose of trade, and the Court of Appeal agreed with this.

For the above reasons, the Court of Appeal concluded that the payments made under the settlement agreements were not themselves penalties, and that the long-standing restriction on the deductibility of penalties did not extend to payments other than penalties. The payments in question were made in the course of the trade and were wholly and exclusively for the purpose of the trade. As a result, the Court of Appeal allowed ScottishPower’s appeal, deeming the payments as deductible (except the £1 penalty).

Comment

The energy sector is heavily regulated. GEMA, operationally managed by Ofgem, and the North Sea Transition Authority (“NSTA”), have extensive powers to levy fines and penalties.

Whilst the NSTA’s power are limited to levying fines/penalties, GEMA has wider powers to make consumer redress orders and permit it to enter into settlement agreements with energy companies that provide for customer redress. In addition, Ofgem’s Enforcement Guidelines provide extensive guidance for energy companies on steps that may be taken to proactively settle potential enforcement proceedings at an early stage – which will often result in settlement agreements that provide for redress. 

For companies that are tax-paying, the ability to deduct settlement payments made as an alternative form of redress will mean the post-tax cost of making such payments is reduced. Particularly where the sums are material, this may therefore be a relevant consideration in reaching early settlements and agreeing the nature of payments to be made as a result of regulatory breaches. It will also be interesting to see whether the Supreme Court throws any further light on the treatment of consumer redress orders (which were not directly relevant in this case, but were briefly touched on in the Court of Appeal judgment), given that these may be similar in nature to the payments made here but made within a statutory framework.

The case was granted permission to appeal to the Supreme Court on 16 June. As such, the Supreme Court will now have to finally decide whether the rule preventing the deduction of penalty payments for the purpose of calculating taxable profits encompass payments made to consumers/consumer organisations in settlement of regulatory investigations.