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Smith's Potato Estates Ltd v. Bolland (Inspector of Taxes); Smith's Potato Crisps (1929) Ltd v Inland Revenue Commissioners

[1948] 2 All ER 367
[1948] AC 508

(Decision by: Viscount Simon)

Between: Smith's Potato Estates Ltd
And: Bolland (Inspector of Taxes)
Between: Smith's Potato Crisps (1929) Ltd
And: Inland Revenue Commissioners

Court:
House of Lords

Judges:
Viscount SimonLord Porter
Lord Simonds
Lord Normand
Lord Oaksey

Subject References:
Excess Profits Tax
Deductions
Cost of litigation
Appeal vital to retain services of valuable employee
Income Tax
Deductions
Cost of Litigation
Appeal vital to retain services of valuable employee

Legislative References:
Income Tax Act 1918 (c 40) - sched D, Rules Applicable to Cases I and II, r 3 (a)
Finance Act 1940 (c 29) - s 32(1)
Finance (No 2) Act 1939 (c 109) - s 14(1)

Case References:
Allen v Farquharson Bros & Co, considered - (1932) (17 Tax Cas 59)
Worsley Brewery Co Ltd v Inland Revenue Comrs, considered - (1932) (17 Tax Cas 349)
Strong & Co Ltd v Woodified - [1906] AC 448; 75 LJKB 864; 95 LT 241; 5 Tax Cas 215; 28 Digest 57, 290
Smith v Lion Brewery Co Ltd - [1911] AC 150; 80 LJKB 566; 104 LT 321; 5 Tax Cas 568; 75 JPJo 87; 28 Digest 57, 291
Usher's Wiltshire Brewery Ltd v Bruce - [1915] AC 433; 84 LJKB 417; 112 LT 651; 6 Tax Cas 399; 28 Digest 56, 286
British Insulated & Helsby Cables v Atherton - [1926] AC 205; 95 LJKB 336; 134 LT 289; 28 Digest 52, 264
Allen v Farquharson Bros & Co - (1932) 17 Tax Cas 59, Digest Supp
Mersey Docks & Harbour Board v Lucas - (1883) 8 App Cas 891; 53 LJQB 4; 49 LT 781; 48 JP 212; 2 Tax Cas 25; 28 Digest 21, 104
Rushden Heel Co Ltd v Keene (Inspector of Taxes), Rushden Heel Co Ltd v Inland Revenue Comrs - [1947] 1 All ER 699
Worsley Brewery Co Ltd v Inland Revenue Comrs - (1932), 17 Tax Cas 349

Hearing date: 19, 20, 22, 23 APRIL 1948
Judgment date: 14 JULY 1948
To secure a supply of potatoes for the purpose of their business a company formed and held all the shares in a subsidiary company which, with the parent company's money, acquired a large estate, previously managed for many years by an experienced farmer, Y. To retain Y's services, the subsidiary company entered into an agreement with him under which he was paid, in the accounting year ending 31 March 1941, £6,486, which was included in the accounts of the subsidiary company. In computing the profits of the subsidiary company (which were included in the parent company's profits for assessment to excess profits tax for that chargeable accounting period), the Commissioners of Inland Revenue decided that for excess profits tax purposes no deduction should be allowed in respect of Y's remuneration in excess of £3,500, being the amount the commissioners considered reasonable and necessary having regard to the requirements of the trade or business and to the actual services rendered by Y. Both companies, regarding Y's employment as essential to the well-being of the enterprise and fearing they would suffer through Y's discontent, appealed to the Board of Referees against this decision and the Board held that £5,800 out of the sum of £6,486 was deductible. As a result, the commissioners did not seek to disallow any part of Y's remuneration in subsequent years. The subsidiary company incurred legal and accountancy costs of £622 in the preparation and prosecution of the appeal:-
Held - (Viscount Simon and Lord Oaksey dissenting) the legal and accountancy costs incurred were not a disbursement "wholly and exclusively laid out of expended for the purposes of the trade" within the meaning of r 3 (a) of the Rules Applicable to Cases I and II of sched D to the Income Tax Act, 1918, and so were not deductible by the subsidiary company for the purposes of its assessment to income tax and were not deductible by the parent company for the purpose of the assessment subject to excess profits tax.
Dicta of Lord Loreburn LC and Lord Davey in Strong & Co Ltd v Woodifield ([1906] AC 448, 452, 453), applied.
Dictum of Viscount Cave LC in British Insulated & Helsby Cables v Atherton ([1926] AC 205, 211, 212), considered.
Allen v Farguharson Bros & Co (1932) (17 Tax Cas 59) and Worsley Brewery Co Ltd v Inland Revenue Comrs (1932) (17 Tax Cas 349), considered.
Decision of Court of Appeal ([1947] 1 All ER 704), affirmed.
Notes
As to Expenses Wholly or Exclusively Expended for Purposes of Trade, see Halsbury, Hailsham Edn, Vol 17, p 152, para 312; and for Cases, see Digest, Vol 28, pp 42-44, 56, 57, Nos 215-266, 286-292.
Consolidated Appeals
Consolidated Appeals by the taxpayers from a decision of the Court of Appeal (Lord Greene MR Morton and Somervell LJJ), dated 2 April 1947, and reported [1947] 1 All ER 704.
The Special Commissioners had disallowed a deduction, for the purposes of income and excess profits tax, of legal and accountancy costs incurred by the first appellants in successful appeals by both appellants against the proportion of the remuneration of an employee which was allowable in computing the profits of the first appellants, a company subsidiary to the other taxpayer, assessable to excess profits tax. Atkinson J allowed the appeals by the taxpayers, but his decision was reversed by the Court of Appeal. The House of Lords now affirm, by a majority, the decision of the Court of Appeal. The facts appear in the opinion of Lord Porter.
Their Lordships took time for consideration.
14 July 1948.  The following opinions were delivered.

Decision by:
Viscount Simon

My Lords, I have had the advantage of studying the opinions prepared by my colleagues who sat with me in hearing the arguments in these consolidated appeals, and as these opinions are not unanimous I feel that I should briefly express my own conclusion, even though this will not affect the ultimate result. It is not necessary for me to set out the detailed facts in these two cases. They are fully stated in the opinion about to be delivered by my noble and learned friend, Lord Porter.

The main question to be decided is whether the legal and accountancy expenses of prosecuting an appeal (in this instance, a successful appeal) to the Board of Referees against a decision of the Commissioners of Inland Revenue under s 32 of the Finance Act, 1940, incurred by a taxpayer with a view to reducing the assessment made on him as a trader for excess profits tax, can be deducted as being a disbursement "wholly and exclusively laid out or expended for the purposes of the trade": r 3(a) of the Rules Applicable to Cases I and II of sched D. The commissioners had fixed the proper figure for an item of disbursement at £3,500. The result of prosecuting the appeal, at a cost of £622 10s 11d, was to establish that the proper figure was £5,800. Atkinson J held that the expense of £622 10s 11d was an admissible deduction on the ground that the cost of the litigation was incurred for the purpose of ascertaining the true figure of profits on which the trader must bear excess profits tax. The Court of Appeal (Lord Greene MR Morton and Somervell LJJ) reversed this decision, holding that the disbursement was not "wholly and exclusively" incurred for the purposes of the trade, but was, at any rate in part, incurred in an endeavour to reduce the amount of tax which the taxpayer had to pay. It is to be observed that the size of the figure to be deducted-£5,800 instead of£3,500-not only affects the correct calculation of excess profits tax for the year, but also the adjustment later on of the total burden of such tax to be borne by the trader. Moreover, since excess profits tax is deductible as an expense when calculating the proper assessment of the trader to income tax, the fixing of a correct figure for the former is essential to the correct calculation of the latter, and it is only when the latter is ascertained that the trader knows how much of his commercial profit he can carry forward, or, if a company, how much of the year's profit is available for dividend or for reserve.

It seems to me that it is essential for the proper carrying on of a trade that the trader should know what portion of his profits in a given year is left to him after the Revenue has taken its share by taxation. If, therefore, he considers that the Revenue seeks to take too large a share and to leave him with too little, the expenditure which the trader incurs in endeavouring to correct this mistake is a disbursement laid out for the purposes of his trade. If he succeeds, he will have more money with which to earn profits next year. It is true that the result of his success is to reduce the tax he has to pay - alternatively, one may say that the result is to show that the profit of the year's trading left to him after paying tax is greater than the Revenue was willing to admit - but, to my mind, the purpose was a trading purpose and nothing else. The trade is not to be regarded as extending over twelve months and no more. Indeed, as I have already pointed out, excess profits tax is liable to be adjusted in the light of subsequent trading results, and assessment for income tax is arrived at on figures of the previous year. With all respect to those who think otherwise, I regard it as fallacious to argue that the trader's expenditure in fighting the Revenue's assessment is not "wholly and exclusively" incurred for the purposes of the trade because the expenditure would not be incurred if there was no tax to pay. If there was no tax to pay, the benefit realised by the trader from carrying on the trade would not be reduced by taxation, and it is the purpose of trade (at any rate, under private enterprise) to make its legitimate profit.

Viewed in this light, I do not see why the expenditure here in question is not wholly and exclusively laid out for the purposes of the trade - if it had not been incurred, the trade would be less profitable. Lord Davey's gloss on the words of the statute in Strong & Co Ltd v Woodifield ([1906] AC 448, 453) is well known, but I think it is better to concentrate on the statutory words themselves. Rightly understood, however, I do not find that Lord Davey's words contradict the view I am disposed to take. Strong & Co Ltd v Woodifield was a case in which the taxpayer sought to deduct a loss not connected with or arising out of his trade. Lord Loreburn said (ibid, 452):

"I think only such losses can be deducted as are connected with, in the sense that they are really incidental to, the trade itself."

Lord Davey's test was that the purpose of the expenditure must be "the purpose of enabling a person to carry on and earn profits in the trade ... " (ibid, 453). Here, the expenditure was, in my view, incurred for the purpose of carrying on and earning profits in the trade, for a reduction in the amount of tax does increase the fund in the trader's hands after tax is paid and so promotes the carrying on of the trade and the earning of trading profits. The incidental consequence that the trader is not taxed so heavily in respect of his profits from trade does not, as it seems to me, alter the fact that the litigation was wholly and exclusively undertaken for the purposes of the trade. My own opinion, therefore, would be that the appeal should be allowed, but, in view of the opinion of the majority of your Lordships, I move that it be dismissed with costs.


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