An onerous contract is a contract in which the aggregate cost required to fulfill the agreement is higher than the expected economic benefit. Such a contract can be a major financial burden for a trading entity. A lump sum payment which is made in order to be released from an onerous contract is not an allowable deduction just because the payments which would have been made under the contract would themselves have been deductible. However, the whole lump sum will, be a revenue item which is deductible in computing the profit of the accounting period in which it is paid, if it relates to the trading arrangements of the business. The lump sum must not create, relate to or enhance the value of a capital asset, and must be paid wholly and exclusively for the purposes of the trade.
This rule was laid down in Anglo-Persian Oil Co Ltd1. The company had a contract with another company for the latter to act as its agent on a commission basis. In the course of time the amounts of commission
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