The Post Office unlawfully claimed £934m tax relief for its compensation payments, and now faces an unexpected £100m tax bill.

The Post Office has claimed a £934m tax deduction for its compensation payments to the victims of the Post Office scandal. That’s outrageous – and also unlawful. The consequence is that the Post Office has underpaid its corporation tax by over £100m over the last five years, and may no longer be solvent.

We understand that HMRC are actively pursuing this point – and it’s just one of five major Horizon scandal matters where the Post Office has, we believe, materially underpaid its tax. The Post Office failed to declare these issues in its accounts until this year, when it included an obscure reference which failed to adequately disclose the point.

The FT is covering our report here.

How do we know there’s a liability?

The Post Office’s report and accounts for 2022/23 suggest there is a serious potential tax problem that could result in it becoming insolvent:

And again on page 70:

and on page 82:

We’d expect so serious a contingent liability to be disclosed in the notes to the accounts – it is mentioned, but with nothing specific:

The only hint as to what the issue could be is in the small print on page 101:

So we know this relates to historic periods, that nothing was disclosed until this year (none of these disclosures were included in previous accounts), and that it is something to do with the provisions/expenses and funding income relating to the Post Office’s compensation payments to victims of the scandal.

We can also take from this that the Post Office is under investigation by HMRC (either an HMRC enquiry and/or a discovery assessment).¹The term “investigation” is often used, but technically that is not a term of art – any query from HMRC as to the accuracy of a recent corporation tax return is technically an “enquiry”; a discovery assessment is the process for re-opening previous years that would otherwise be past the point of correction. Both have legal consequences.

What is the liability?

Our team of eminent tax and accounting experts has reviewed the Post Office’s accounts for the last ten years in detail and one issue stands out: it has treated the compensation it pays to postmasters as tax deductible. That is not correct.

A source at the Post Office has confirmed to us that HMRC is investigating this and asserting that the Post Office owes tax – in our view they are right to do so.

Background

Most payments made by a trading company are deductible for tax purposes. However, a deduction is only permitted for a payment made “wholly and exclusively” for the purposes of the trade. At this point we cannot say with certainty why the Post Office falsely accused 4,000+ postmasters of theft, but we can be sure it was not for any bona fide purpose of its trade. The Post Office’s actions were, as the Court of Appeal put it, an affront to the conscience of the court – unlawful and very plausibly criminal.

It follows that all expenses connected with the Post Office’s persecution of the postmasters are non-deductible – including (but not limited to) compensation and provisions for compensation. There are many cases on this point, but none with facts as extreme as the Post Office scandal²The leading case is probably still Strong & Co of Romsey Ltd v Woodifield. A customer sleeping at an inn was hurt when a chimney collapsed on him, because the company had breached its duty to maintain the property. The company had to pay costs and damages, and the House of Lords ruled this was non-deductible. Here, whatever the precise reasons for the Post Office’s actions, to say it “breached its duty” would be a significant under-statement. Other relevant cases include Cattermole v Borax Chemicals Ltd [1949] (payments to settle potential fines in the US were non-deductlble) and Fairrie v Hall [1947] (libel damages are ordinarily not deductible, although newspapers are different). – the position is, in the view of our team, reasonably clear.

We understand from our source that the Post Office is contesting HMRC’s position that the compensation payments are non-deductible. We believe the Post Office’s prospects of success are low.

The total deductions wrongly claimed by the Post Office

We can find the data on the deductions taken for compensation payments by looking the notes in the account for the last five years.³See page 97 of the 2022/23 accounts, page 98 of the 2021/22 accounts, page 73 of the 2019/20 accounts. The totals are shown below. All figures are £m.⁴We’re following the accounts convention that positive numbers here are losses booked in the accounts for the compensation provisions, and negative numbers are reversals of the provisions.

In other words, a total of £934m has been claimed – improperly.

There was a partial reversal of the provisions in the most recent year (2022/23), however that will not change the corporation tax liability for previous years.

The impact of reversing those provisions

Like most companies, the Post Office does not disclose its actual corporation tax liability for each year. However we can infer this by looking at the figures in its accounts for tax losses brought forward each year. The change in tax losses broadly reflects its taxable profit for each year (i.e. because a further tax loss increases brought-forward losses, and a taxable profit reduces them).

On that basis, we estimate the Post Office’s taxable profit for each year as follows (£m):

The next step is to adjust this inferred taxable profit to reflect the reversal of the tax deduction. That profit will then be reduced by the Post Office’s considerable carried-forward losses; but a change of law in 2017 means that no more than half of a current year profit can be sheltered by brought-forward losses.⁵After an allowance of £5m which can be entirely sheltered by losses. Note that as the Post Office’s losses end up being exhausted by the reversal of the provision, the loss restriction rule ends up having little effect (other than to decelerate loss utilisation and therefore slightly increase the interest charge). Interestingly, and probably not by coincidence, the Post Office’s accounts disclose the loss utilisation point this year, never having mentioned it in the past (despite having large losses).

So we can model the impact on the Post Office as follows:

This figure needs to be treated with caution, and as an approximation.⁶In particular, it doesn’t take account of loss surrenders (although that likely means the same amount of tax would be collectable, but from other entities). The full calculations are available here.

However it seems likely that the Post Office has a corporation tax liability of over £100m.

There is also the question of penalties: the non-deductibility of compensation for unlawful acts is a well-known point, and the Post Office certainly knew that its actions had been unlawful. It was careless. Hence we would expect HMRC to consider penalties of up to 30%, with the precise figure depending on the facts, and in particular whether this was a “prompted” disclosure by the Post Office (i.e. whether the Post Office approached HMRC with this issue or whether, alternatively, HMRC identified it).

The Post Office’s response

We asked the Post Office for comment on a potential undisclosed £100m tax liability. They said:

“The disclosed information on taxation in Post Office’s Annual Report and Accounts for 2022/23, published on 20 December 2022, is appropriate and accurate. Discussions with HMRC and the Department of Business continue.”

(Presumably this is a typo, and they meant to say “20 December 2023”)

We read this as confirmation that our findings are accurate, and that the Post Office is under HMRC investigation. We also note that the Post Office is asserting that the disclosure in this year’s accounts is appropriate (we disagree) but not defending the accuracy of its previous years’ accounts.

The other tax liabilities

The Post Office likely has other significant underpaid corporation tax resulting from the scandal, in addition to the £100m we estimate above. We can identify four particular issues:

First, the “shortfalls” it recovered from postmasters, which supposedly represented the return of money they had stolen, but actually represented a windfall for the Post Office. This income should have been included in the Post Offices taxable profits⁷The demand for payments of shortfalls was unlawful, and potentially a criminal offence, but unlawful/illegal income is taxable if (very broadly) it forms part of a systemic activity – there is helpful HMRC guidance here. So, for example, a drug dealer’s profits were taxable. We are confident the Post Office’s “shortfall” receipts were taxable too.; was it?⁸Nick Wallis has written about what happened to the shortfall money here.

Second, the Post Office will have non-deductible costs dating back to the inception of the scandal, including the costs of falsely prosecuting postmasters between 2000 and 2015 (which we would say were unlawful/illegal actions carried outside the course of the trade and therefore are not deductible).

Third, the Post Office has claimed a deduction for all of its legal fees and other costs of fighting the postmasters’ claims, and of dealing with the Inquiry. We do not know the full amount, but we expect it is several hundred million pounds (given that the postmasters’ costs for the civil claim alone were £150m). Some of this may be deductible; other amounts (particularly for pursuing unjustifiable positions) may in our view not be. We await the Inquiry’s conclusions on the appropriateness of the Post Office’s actions in this regard.

Finally, and most significantly, the Post Office has been receiving funding from Government in a form which may be taxable. If a shareholder pays cash to a company to subscribe for shares, the cash isn’t taxable for the company. If a shareholder makes a cash loan to a company, the loan advance isn’t taxable. But if the shareholder just gives money to a company, to supplement its trading receipts and enable it to carry on in business, then that will be a taxable trading receipt. HMRC guidance on this is clear – and so businesses typically never obtain funding in the form of simple gifts. But, for unknown reasons, that’s what happened here (again suggesting a basic lack of competence at the Post Office).

Possibly the Post Office can argue that the funding from Government is a special case which doesn’t give rise to a profit;⁹By analogy with BBC v Johns – however the facts here are different. but our understanding from the accounts disclosure and a source at the Post Office is that HMRC believes the amounts are taxable. This was confirmed by the Post Office yesterday – the FT asked the Post Office if it had written to HM Treasury to complain about HMRC and they responded:

“We have regular conversations with Government who are our sole shareholder. Our correspondence in respect of this issue was about ensuring that the tax treatment of compensation was treated in the same way as other government funding that we receive.”

This suggests the Post Office is very confused.¹⁰We believe the statement means to say “the tax treatment of funding for compensation” The tax treatment of gifts will not be “treated in the same way” as funding by way of share capital or loans, because a gift is not the same as a share subscription or loan. It is, furthermore, not appropriate for the Post Office to write to the Government to lobby for HMRC to treat it differently from other companies – the Post Office is supposed to be managed at arm’s length.

Ordinarily HMRC cannot recover tax from more than (broadly speaking) six years ago, but it can go back 20 years where an action was deliberate. That may be the case here.¹¹The point is not straightforward. The Post Office’s actions were clearly deliberate, but we expect they paid no heed to tax at all. Was the loss to tax “brought about deliberately“? It may be difficult in practice to quantify the amounts in question, particularly given what appears to be poor record-keeping on the part of the Post Office. That would (rightly) not stop HMRC pursuing the point against a normal commercial taxpayer – HMRC would require that the Post Office provide the best figures available for the potentially taxable and non-deductible items we identify.

We would hope HMRC will pursue all these points, and that it will disregard any attempt at political interference from the Post Office.

The interest is likely to be a significant amount and, again, penalties may be chargeable (particularly if the misappropriated “shortfalls” were not taxed as income).

Does it matter?

Taxes go to HMRC, a non-ministerial Government department. The Post Office is wholly owned by the Government. Does it matter how much tax the Post Office pays?

We would say it does:

• The Post Office should follow the law, just like every other company.
• The Post Office has boasted about finally making a trading profit. Our findings show that it has in fact made a very substantial loss.
• Bonuses have been paid to the executive team based on an apparent level of profitability which does not exist.
• The existence of a £100m+ hole in the accounts suggests that the Post Office has an alarming lack of the usual financial controls one would expect from a business of this size.
• It is inappropriate that the point was not disclosed at all in previous years’ accounts, and was disclosed only very elliptically in the most recent accounts.
• Has the Post Office informed the Government, as its shareholder, as to the true state of its accounts and tax position?
• It is possible that this liability means that the Post Office is in fact insolvent.

This all raises the question of whether, in accordance with the Post Office’s published policies, bonuses paid to its executive team should be reduced or returned:¹²See page 39 of the 2022/23 accounts

It also raises the question: if the management team can miss a £100m black hole, what else are they missing?

Thanks to K1 for asking the question which led to this analysis, Heather Self (one of the UK’s most respected corporate tax advisers) of Blick Rothenberg, together with K2, D, and X for generously providing their expertise on non-deductibility of compensation payments, and to C for his invaluable tax accounting input. And many thanks to Emma Agyemang at the FT for her help developing this report.

• 1
  The term “investigation” is often used, but technically that is not a term of art – any query from HMRC as to the accuracy of a recent corporation tax return is technically an “enquiry”; a discovery assessment is the process for re-opening previous years that would otherwise be past the point of correction. Both have legal consequences.
• 2
  The leading case is probably still Strong & Co of Romsey Ltd v Woodifield. A customer sleeping at an inn was hurt when a chimney collapsed on him, because the company had breached its duty to maintain the property. The company had to pay costs and damages, and the House of Lords ruled this was non-deductible. Here, whatever the precise reasons for the Post Office’s actions, to say it “breached its duty” would be a significant under-statement. Other relevant cases include Cattermole v Borax Chemicals Ltd [1949] (payments to settle potential fines in the US were non-deductlble) and Fairrie v Hall [1947] (libel damages are ordinarily not deductible, although newspapers are different).
• 3
  See page 97 of the 2022/23 accounts, page 98 of the 2021/22 accounts, page 73 of the 2019/20 accounts
• 4
  We’re following the accounts convention that positive numbers here are losses booked in the accounts for the compensation provisions, and negative numbers are reversals of the provisions.
• 5
  After an allowance of £5m which can be entirely sheltered by losses. Note that as the Post Office’s losses end up being exhausted by the reversal of the provision, the loss restriction rule ends up having little effect (other than to decelerate loss utilisation and therefore slightly increase the interest charge).
• 6
  In particular, it doesn’t take account of loss surrenders (although that likely means the same amount of tax would be collectable, but from other entities).
• 7
  The demand for payments of shortfalls was unlawful, and potentially a criminal offence, but unlawful/illegal income is taxable if (very broadly) it forms part of a systemic activity – there is helpful HMRC guidance here. So, for example, a drug dealer’s profits were taxable. We are confident the Post Office’s “shortfall” receipts were taxable too.
• 8
  Nick Wallis has written about what happened to the shortfall money here.
• 9
  By analogy with BBC v Johns – however the facts here are different.
• 10
  We believe the statement means to say “the tax treatment of funding for compensation”
• 11
  The point is not straightforward. The Post Office’s actions were clearly deliberate, but we expect they paid no heed to tax at all. Was the loss to tax “brought about deliberately“?
• 12
  See page 39 of the 2022/23 accounts