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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

(Judgment by: Lord Oaksey)

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 Simon
Lord 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.

Judgment by:
Lord Oaksey

My Lords, the question in this appeal is whether the costs of litigation undertaken for the purpose of arriving at the true profits of a trade for the purposes of taxation are proper deductions in order to arrive at the balance of profits and gains or as expenses wholly and exclusively laid out or 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. The contention on behalf of the Crown is that no expenses connected with taxation are deductible because it is said they are not expended for the purposes of the trade and it is sought to limit the words "the purposes of the trade" to the purpose of earning the profits of the trade by the operations of the trade. Reliance is placed on the dictum of Lord Davey in Strong & Co Ltd v Woodifield ([1906] AC 448, 453), which has frequently been cited with approval in other cases, but it is to be observed that Lord Davey did not say earning the profits by the operations of the trade and, in my opinion, the words "the purposes of the trade" ought not to be construed in this way. A trader does not expend money in an action brought for or against him for negligence or breach of contract in the course of his trade for the purpose of earning the profits of the trade in this sense, for it is not an operation of his trade to engage in litigation. It is, of course, an incident which he may think reasonably necessary for the purposes of his trade to bring or defend actions, but so it is an incident which he may think reasonably necessary for the purposes of his trade to engage in litigation as to the amount of his taxes. If he succeeds in either case he increases the profits arising from his trade, and it appears to me to be no straining of language to say that a trader who increases his profits by incurring a certain expense incurs that expense for the purpose of earning the profits.

In my opinion, the real question which has to be decided in every case is whether the expense is one which is incurred in order to earn gain or profit from the trade, or is the application of the gain or profit when earned: see per Lord Selborne LC in Mersey Docks & Harbour Board v Lucas ([1883] 8 App Cas 891, 906), and, in my opinion, it cannot be truly said that the expense of paying accountants or of litigating the question of what is the balance of profits and gains for the purposes of taxation is the application of these profits. Profits cannot properly be applied or divided until they are ascertained, and every expense which is properly incurred for the ascertainment of profits is, in my opinion, an expense of earning the profits and not an application of them. That is not to say that all expenses which are incurred in point of time before the profits are ascertained can be deducted. The point of time is unimportant. Some expenses which are clearly the application or distribution of profits may be incurred before the ascertainment of profits, eg, capital investments or payments of interim dividends, but it is the character of the expense which must be considered. The expense in this case was not a capital investment. It was incurred, not to distribute, but to increase, and, in that sense, to earn, the profits. On the other hand, if it is to be held that such expenses are not deductible, what is to be said of the costs of audit which the Companies Acts make necessary or of that part of the cost of bookkeeping which is used in the preparation of such an audit or of accounts for taxation? They are not incurred for the purposes of earning the profits of the trade in the limited sense contended for by the Crown. It is said that the expense of litigating questions of taxation has never been sought to be deducted, and it may be so, but it is also true that the expense of paying accountants and auditors has been deducted, and, in any event, the fact, if it be the fact, throws no legal light on the construction of the words in question. For these reasons I am in favour of allowing the appeals.


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