Ostime (Inspector of Taxes) v Australian Mutual Provident Society

[1960] A.C. 459

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(Judgment by: Lord Radcliffe)

Between: Ostime (Inspector of Taxes) - Appellant
And: Australian Mutual Provident Society - Respondent

Court:

Judges:
Lord RadcliffeLord Tucker
Lord Somervell of Harrow
Lord Denning
Lord Birkett

Subject References:
REVENUE
INCOME TAX
DOUBLE TAXATION RELIEF
Life assurance
Mutual life assurance association in Australia
Branch office in United Kingdom
Assessments to income tax on life fund interest
Competence of assessments
'Industrial or commercial profits'
Whether taxable surpluses properly so described

Legislative References:
Income Tax Act, 1918 (8 & 9 Geo. 5, c. 40) - Sch. I, Sch. D, Rules applicable to Case III, r. 3
Income Tax Act, 1952 (15 & 16 Geo. 6 & 1 Eliz. 2, c. 10) - s. 430
Double Taxation Relief (Taxes on Income) (Australia) Order, 1947 (S.R. & O., 1947, No. 806) - Sch., art. II (1) (i), (3); art. III (2), (3)

Hearing date: 4, 8-9 June 1959
Judgment date: 16 July 1959

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Judgment by:
Lord Radcliffe

My Lords, the sole question raised by this appeal is whether the respondent, an Australian life assurance company, can be lawfully assessed to income tax in this country under rule 3 of Case III of Schedule D to the Income Tax Act, 1918 (or, as the rule has become, section 430 of the Income Tax Act, 1952), having regard to the obligations undertaken by the Government of the United Kingdom in the Double Taxation Relief Agreement entered into with the Government of the Commonwealth of Australia on October 29, 1946. The question itself is said to be a short one, as in one sense it is: but it is not so easy to state it shortly, and, since its solution requires a certain amount of introductory matter, I must ask leave to take a rather longer time than I should have wished in setting my opinion before your Lordships.

The relevant facts are these. The respondent is a mutual insurance society incorporated in the state of New South Wales. It has its head office in Sydney and a branch office in London: from these offices it carries on a business of life assurance. It is not in dispute that for the purposes of taxation in this country its life assurance business is to be treated as a business separate from any other class of business carried on by it and the assessments which are the subject of appeal are confined to the income or profits of that business.

These assessments relate to a number of years, beginning with the revenue year 1947-48 and ending with the year 1953-54. Those for the first five years were made under rule 3 of Case III of Schedule D to the Income Tax Act, 1918; those for the last two under section 430 of the Income Tax Act, 1952, which Act replaced the earlier Act in the process of consolidation. As the provisions of the two Acts do not differ in any relevant particular I shall speak throughout of rule 3 as the governing statutory provision.

The course that the case has taken in the courts below is that the assessments raised by the appellant were discharged by the special commissioners on the respondent's appeal and the order of the special commissioners has been upheld in the High Court (Upjohn J.) and in the Court of Appeal (Jenkins, Parker and Pearce L.JJ.). In all courts hitherto the same view has prevailed, that there is a conflict between the provisions of rule 3 and those provisions of the Double Taxation Relief Agreement which deal with the taxation of industrial or commercial profits and that this conflict precludes for the future an effective assessment under the rule.

I should add at this point that the agreement became municipal law of this country by virtue of an Order in Council made on April 23, 1947, under the authority given by section 51 (1) of the Finance (No. 2) Act, 1945, which allows the enactment by such Orders of the arrangements contained in double taxation relief agreements and prescribes further that the arrangements covered by an Order shall have effect in relation to income tax notwithstanding anything in any enactment "so far as they provide for relief from tax, or for charging the income arising from sources in the United Kingdom to persons not resident in the United Kingdom, determining the income to be attributed to such persons and their agencies, branches or establishments in the United Kingdom, ..." It is plain, therefore, that, if there is a conflict, the unilateral legislation of the United Kingdom must give way.

The decisions in the High Court and the Court of Appeal were dominated by the view taken in those courts as to the effect of the opinions delivered in this House in an earlier case involving the present respondent, which is reported as Inland Revenue Commissioners v. Australian Mutual Provident Society. Both courts treated that case as deciding that the rule 3 assessment was an assessment and therefore a tax upon the profits of the business of life assurance and as such was a tax upon commercial profits within the meaning of the Double Taxation Relief Agreement. I do not think that the first part of this proposition has been denied at any stage by the argument for the Crown, though it challenges the deduction to be drawn from it as to the interpretation of the agreement. However that may be, I am reluctant that the issue of this appeal should be determined by any exclusive reliance upon what was said by members of this House in the earlier case, since the point that had then to be decided, relating as it did to the applicability of certain provisions about tax-free interest to a rule 3 assessment, has no direct bearing upon the present dispute, and in any event nothing said by the House in 1947 could amount to an interpretation of the words "commercial or industrial profits" in the agreement, which was not then before them. I therefore defer until later any further reference to this case.

My Lords, I think that what has to be done is first to ascertain what was the nature of the taxation imposed by rule 3, so far as that very special enactment admits of any clear categorisation, and then to ask whether or not taxation on that basis can still be imposed consistently with the obligations undertaken by the United Kingdom under the Double Taxation Relief Agreement. I will set out rule 3 in the form in which it appears in the Income Tax Act of 1918, but before I do so I must make one cautionary remark. The framers of the rule were concerned to extract what seemed to them a fair quantum of tax from what had hitherto been an unsatisfactory situation. They were not concerned with precise distinctions between commercial and investment income, which in any event do not always admit of such distinction: nor could they be expected to foresee either the contents or the wording of the Double Taxation Relief Agreements which have become a feature of post-1946 tax administration.

"3.(1)

Where an assurance company not having its head office in the United Kingdom carries on life assurance business through any branch or agency in the United Kingdom, any income of the company from the investments of its life assurance fund (excluding the annuity fund, if any), wherever received shall, to the extent provided in this rule, be deemed to be profits comprised in this Schedule and shall be charged under this Case.

"(2)

Such portion only of the income from the investments of the life assurance fund for the year preceding the year of assessment shall be so charged as bears the same proportion to the total income from those investments as the amount of premiums received in that year from policy holders resident in the United Kingdom and from policy holders resident abroad whose proposals were made to the company at or through its office or agency in the United Kingdom bears to the total amount of the premiums received by the company:

"Provided that in the case of an assurance company having its head office in any British possession, the Commissioners of Inland Revenue may, by regulation, substitute some basis other than that herein prescribed for the purpose of ascertaining the portion of the income from investments to be so charged as being income derived from business carried on in the United Kingdom.

"(3)

Every such charge shall be made by the special commissioners as though the company under the provisions of this Act had required the proceedings relating to the charge to be had and taken before those commissioners.

"(4)

Where a company has already been charged to tax, by deduction or otherwise, in respect of its life assurance business, to an amount equal to or exceeding the charge under this rule, no further charge shall be made under this rule, and where a company has already been so charged, but to a less amount, the charge shall be proportionately reduced."

Rule 3 first became law in 1915, being introduced by section 15 of the Finance Act of that year. The situation that it was framed to deal with needs to be shortly stated: it arose from a combination of the special difficulties of establishing the true annual profit of life assurance business with the special difficulties of determining the true United Kingdom income of a non-resident life assurance company doing branch business here. If that assurance company was organised on the mutual principle, a further difficulty was superimposed: but this particular difficulty was due to the quirk of English judicial reasoning which absolved a mutual company from the possibility of making a taxable profit and could have been corrected at any time by appropriate legislation.

It had never been easy or convenient to raise an assessment under Case I of Schedule D on a life assurance society in respect of its trading income. To do so involved valuations of liabilities and assets which were not likely to be annually available. On the other hand, life assurance business by its own nature generates the life fund consisting of investments made out of the premium receipts and accumulated income and the produce of those investments is at least an important part of the annual income of the business. So long, therefore, as the investments were such as to yield interest or dividends from a source in the United Kingdom, the interest and dividends themselves fell under charge to tax and, given the allowance to the company of its management expenses, an adequate, though never an accurate, measure of the annual profit accruing to the business could be regarded as obtained.

Moreover, since 1914 a company with its head office here had been liable on the income of foreign investments, even if not remitted to this country. A foreign assurance company was, however, in a different position. If it did business in the United Kingdom through a branch, it was not itself a resident and, as a non-resident, could not fairly be regarded as taxable in this country in respect either of its world income from investments or, more generally, its world income from life assurance business. So far as its life fund was represented by United Kingdom securities and no special tax exemption attached to them, it was liable to bear tax on the income from the securities. Theoretically, too, it was liable to an assessment under Case I of Schedule D in respect of the profits from its business carried on in the United Kingdom. But then a foreign assurance company might well not keep its life fund or at any rate any substantial part of it invested in United Kingdom securities, so the tax yield on that ground was only a speculative amount: while the problem of raising a valid Case I assessment on the profits of the United Kingdom trade carried on by a branch office which was not even under the obligation of maintaining an independent accounting system was evidently regarded as too vexing for solution.

If it is seen against this background, it is fairly clear what rule 3 was designed to effect. Its purpose was to attribute to a foreign assurance company doing life business here a reasonable sum of income or profits in respect of that business and so to tax that sum as income arising in the United Kingdom. In one sense it charged the income of all the investments of the life fund wherever received and in that sense was a tax on investment income; but the language of the taxing provision and, indeed, the whole scheme of it is so exceptional that I do not think it right to give any determining weight to that consideration.

As I have indicated, it was not unusual to regard the income of the life fund as an acceptable alternative to the trading income of the business. In the end it is not the investment income itself that is the subject of tax but the product of a mathematical calculation represented by the income of the whole life fund multiplied by premiums obtained through United Kingdom business over the company's total premium income. It is the sum produced by this calculation that is "deemed to be profits comprised in" Schedule D and charged under Case III. This sum, representing an unidentifiable portion of the income from investments, is "charged as being income derived from business carried on in the United Kingdom" (see the proviso to rule 3 (2)).

I regard these last words as very important, for to my mind they indicate conclusively the nature of the taxing provision as being designed to attribute to the foreign taxpayer a measure of income to represent the income of his United Kingdom business. It follows that the effect of the charge is not to charge investments "as such" or any specific investments. Finally, the fact that, under rule 3 (4), the tax charge turns out to be only a supplementary or covering charge which abates or disappears to the extent that tax is otherwise obtained by deduction from investment income or direct assessment seems to me to make it very difficult to regard the nature of the taxing provision as being other than that which I have described.

The question we have to determine is how this method of attributing a profit to a life assurance company whose head office is outside the United Kingdom stands up against the provisions of the Double Taxation Relief Agreement. I should find nothing surprising in the conclusion that it had been superseded. Rule 3 was an attempt at a unilateral solution of this particular aspect of double taxation in which the Australian taxing authorities were certainly no less interested than the authorities of the United Kingdom. Bilateral agreements for regulating some of the problems of double taxation began, at any rate so far as the United Kingdom was concerned, in 1946.

The form employed, which, for obvious reasons, employs similar forms and similar language in all agreements, is derived, I believe, from a set of model clauses proposed by the financial commission of the League of Nations. The aim is to provide by treaty for the tax claims of two governments both legitimately interested in taxing a particular source of income either by resigning to one of the two the whole claim or else by prescribing the basis on which the tax claim is to be shared between them. For our purpose it is convenient to note that the language employed in this agreement is what may be called international tax language and that such categories as "enterprise," "commercial or industrial profits" and "permanent establishment" have no exact counterpart in the taxing code of the United Kingdom.

Turning then to the agreement, there is no doubt that the respondent is an Australian enterprise and therefore comes within the regulation of article III (2) that its commercial profits are not to be subject to United Kingdom tax at all unless it is engaged in business here through a permanent establishment here. It is conceded that its branch office is such an establishment, and therefore the second part of the regulation applies and tax may be imposed on the respondent's commercial profits by the United Kingdom, but only on so much of them as is attributable to that establishment. It is not left wholly to the will of the United Kingdom taxing authorities to decide the basis on which that attribution of commercial profits is to be made. Article III (3) provides by its terms for a basis which in effect requires the hypothesis that the branch is an independent enterprise dealing as an independent entity at arm's length with the head office. The profits which emerge from a calculation based on this hypothesis are to be "deemed to be income derived from sources in the United Kingdom."

I do not think that it is open to us to decide what would be the consequences of taxing the respondent's commercial profits according to this new formula. It is by no means easy to see what other hypotheses are required or excluded by the central hypothesis. The sole issue under appeal is whether the respondent can be taxed at all on the rule 3 basis. In my opinion it cannot be, because the world income from the investments of the life fund, which forms the first stage in the rule 3 calculation of profits, cannot be attributed to the hypothetical independent enterprise without violating the very hypothesis which article III (3) is designed to lay down as the basis of taxability.

I did not understand the argument for the Crown to maintain that rule 3 could be applied consistently with an assessment according to article III (3). What was said was that, having regard to the definition of "commercial and industrial profits" in article II (1) (i), assessments under rule 3 were not affected by article III (3), since the profits they charged were not commercial or industrial profits within the meaning of the agreement. With all respect to that argument, it seems to me simply a claim to retain the United Kingdom's unilateral basis of attributing United Kingdom business profits to an overseas life assurance company in despite of the new agreed basis of attribution laid down in article III (3). It is quite true that the definition of "industrial or commercial profits" declares that it "includes profits from such activities or business but does not include income in the form of dividends, interest, rents, royalties, ..."

Accordingly, except so far as article VI makes certain special stipulations about double taxation of dividends, the respective claims of the taxing authorities upon items of income such as dividends or interest are not regulated on the "permanent establishment principle" of article III and are left to be taxed according to the local legislation. It would be in accordance with United Kingdom principles to tax all dividends and interest arising from sources in the United Kingdom to whomever accruing, unless specially excepted, but not to tax the foreign income of non-residents. So, in this case, the respondent has regularly borne tax on its United Kingdom interest and dividends; and, for instance, of a total tax claim of £97,961 in respect of the rule 3 assessment for 1953-54, as much as £86,796 is set off by taxes paid by deduction or otherwise under various schedules.

The tax-deducted portion of that is £79,360. Such income is no doubt income "in the form of" dividends or interest for the purposes of article II (1) (i); but when I look round for any other comparable income received in the basis year which could be excluded from the provisions of article III, I find none. Certainly I do not find it in the notional sum of profits attributed under rule 3 to the United Kingdom business, for that sum is not received in the form of dividends or interest and only exists as a measure of profits established by the legislature for the purpose of the attribution, whereas it is just that question whether such a measure is any longer sustainable in face of the Double Taxation Relief Agreement that is the subject of the present dispute. In other words, as I see it, the Crown's argument can only succeed by assuming in its favour the very hypothesis that the agreement displaces by a different standard of calculation.

I have left to the end any detailed reference to the opinions of this House in Inland Revenue Commissioners v. Australian Mutual Provident Association. The issue in that case was different from this one. It turned on the question how, if at all, a rule 3 assessment should take account of the circumstance that some of the life fund investments were by statute free of tax to holders non-resident or not ordinarily resident. When the case began its progress through the courts the general construction of the nature of the rule 3 charge seems to have been governed by Rowlatt J.'s decision in Equitable Life Assurance Society of the United States v. Hills. In that case he had spoken of the charge as a charge on the investment income simpliciter:

"They are taxed on their investments as such, upon a proportion of those investments."

Putting that construction side by side with the later decision of the House of Lords in Hughes v. Bank of New Zealand, the Court of Appeal had held that the rule 3 assessment must be adjusted in favour of the taxpayer to reflect the relief on the exempted income. This House was not prepared to accept that conclusion. I think that it is obvious from the opinions of Lords Simon, Wright and Porter that they did not accept Rowlatt J.'s construction of the rule 3 charge. For instance, Viscount Simon is found describing the rule at one point in his speech6 as one which is made "in respect of the annual profit of [the company's] life assurance business," and at another as "not one which taxes income from investments." Lord Porter in his speech rejects the argument that the charge is imposed on the income from investments and not on profits. The sum charged, he says, does not represent any real income or profit but is merely arrived at by a conventional calculation adopted for the purpose of estimating an otherwise almost incalculable sum. In the view of Lord Wright:

"No specific investments were taxed. ... The charge was a tax on the investment income only as a machinery to tax the general profits of the British business."

My Lords, I have quoted these extracts at some length, because it is in reliance upon their tenor that the courts below have decided against the Crown in the present case. It is true, I think, that it would have been sufficient for the decision of the earlier case if the House had merely confined itself to pointing out, as Lord Wright did, that the rule 3 charge is not in any case a charge upon any specific investments; for, if that is so, it is very hard to see how to carry the relief on particular items of income into the unappropriated proportion. It is true, too, that there is nothing in the earlier case that could amount to an interpretation of the words "commercial or industrial profits" as defined by the Double Taxation Relief Agreement, the point with which we are most immediately concerned. But, at the same time, I cannot help recognising that the decision was a unanimous decision of the House which was directed to analysing and explaining the true nature of the rule 3 charge, and of what it was that by it was brought under charge, in order to determine the validity of the claim for relief that was under appeal, and I should not think it right to propound in this case any analysis of rule 3 that was materially different from the explanation then given unless I was convinced that it was unmaintainable. As it is, I am not faced with this difficulty, since I agree with the observations of the noble Lords that I have quoted, and my own reading of the statute leads me to the same conclusion.

I notice, only to reject, an argument that was presented to, but not pressed upon, us by the Crown to the effect that, as the date of the making of the Double Taxation Relief Agreement preceded by some months the House of Lords decision in the former case, that agreement ought to be interpreted in the light of the view of the effect of rule 3 that had hitherto prevailed and not in the light of the law as laid down by this House. I do not accept that it would make any ultimate difference even if the earlier view were treated as the only relevant one, but perhaps it is sufficient to say that I do not think that such a method of construction as is proposed ought to be applied to a bipartite taxation treaty of this nature. All that can be said in such an agreement is said by article II (3), and that is not sufficient to assist the appellant's case.

I would dismiss the appeal.