Commissioners of Inland Revenue v Blott; Commissioners of Inland Revenue v Greenwood

[1921] 2 A.C. 171

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(Decision by: Viscount Finlay)

Between: Commissioners of Inland Revenue - Appellants
And: Blott - Respondent
Between: Commissioners of Inland Revenue - Appellants
And: Greenwood - Respondent

Court:

Judges: Viscount Haldane
Viscount Cave

Viscount FinlayLord Dunedin
Lord Sumner

Subject References:
REVENUE
Super-tax
Assessment
Shareholder in Company
Distribution of Dividends in the Form of fully paid Shares
Capital or Income
Liability of Shareholder to Super-tax

Legislative References:
Income Tax Act, 1842 (5 & 6 Vict. c. 35) - ss. 40, 54, 163, 164
Finance (1909-10) Act, 1910 (10 Edw. 7, c. 8) - s. 66

Case References:
Bouch v. Sproule applied - (1887) 12 App. Cas. 385
Swan Brewery Co. v. The King distinguished - [1914] A.C. 231

Judgment date: 3 June 1921

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Decision by:
Viscount Finlay

My Lords, the respondent was a shareholder in Hepburn, Gale, and Ross. In the income tax year ending April 5, 1915, he received from the company 500 fully paid-up second preference shares of the nominal value of 1l. each, and in the income tax year ending April 5, 1916, he received 750 like shares. He was assessed to supertax in respect of these shares in each year, and the question in the case is whether these assessments were properly made. The Special Commissioners discharged these assessments.

A case was stated for the opinion of the High Court, and the decision of the Special Commissioners was affirmed by Rowlatt J. and by the Court of Appeal. The present Appeal is brought for the purpose of having it established that supertax is payable on these transactions. Super-tax is payable under the Finance (1909-1910) Act, 1910, in respect of the income of any individual, the total of which exceeds 5,000l., as an additional duty of income tax (s. 66, sub-s. 1).

For the purpose of the super-tax the total income is to be taken to be the total income of the individual from all sources for the previous year, estimated in the same manner as the total income from all sources is estimated for the purpose of exemptions or abatements under the Income Tax Act (s. 66, sub-s. 2). Income tax under Sch. D is levied under the Income Tax Act, 1853 (ss. 2 and 5), in accordance with the regulations of the Income Tax Act, 1842. Sect. 163 of the latter Act provides that any person who proves that the aggregate amount of his income is less than a certain amount, shall be exempted from income tax, and s. 164 provides that the claim for such exemption is to be sent to the Commissioners, together with a declaration and statement setting forth all the particular sources from which the income arises.

For the purpose of super-tax the individual person is dealt with and income from every source is to be taken into account. The whole question in this case is whether the income of the respondent was increased by the transactions resulting in the issue of the second preference shares to which I have referred. The company had accumulated in each of the years 1915 and 1916 a considerable amount of profits. It was, of course, open to them to distribute these amounts by way of dividend to the shareholders. In each of these years, however, a resolution was passed that the profits in hand should be capitalized. The resolution in 1915 was dated February 8 and was in the following terms:-

"Resolved:

1.

That it is desirable to capitalise the sum of 33,333l. 6s. 8d., being part of the undivided profits of the company and accordingly that a bonus at the rate of 33 1/3 per cent. per share, free of income tax, on each of the issued ordinary shares of the company be and the same is hereby declared and that the Directors be and they are hereby authorised to satisfy such bonus by the distribution among the members holding ordinary shares rateably of 33,316 of the unissued second preference shares of 1l. each in the Company credited as fully paid in satisfaction of such bonus.

2.

That so far as such distribution would otherwise involve the issue of fractional certificates for an amount less than 1l. such amount shall be paid and satisfied in cash."

The resolution in 1916 was in the same terms except that the amount to be capitalized was 50,000l. and the procedure adopted in the two years was identical. For convenience I take the year 1915.

On the same day on which the resolution was passed an agreement was entered into between the company and S. J. Bradford on behalf of the shareholders, in which the resolution above set out was recited as also the appointment of Bradford by the directors, pursuant to the 127th of the company's articles of association, to enter into the agreement.

The agreement went on to provide that the company allotted and issued the new second preference shares of 1l. each as specified in the schedule to the agreement, that the shares should be "credited as fully paid up," and that the shares so credited should be accepted in satisfaction of the bonus. In pursuance of these agreements there were allotted to the respondent the 500 and the 750 shares to which this litigation relates. The relative articles of association are No. 123 and those following it. Art. 123 provides that the profits of the company available for dividend shall, subject to the payment of preferential dividends, be applied in payment of dividends on the ordinary shares. No dividend or bonus was to be payable except out of profits (art. 125). Art. 127 reads as follows:-

"127.

Any general meeting declaring a dividend may direct payment of such dividend wholly or in part by the distribution of specific assets, and in particular of paid-up shares of the Company or paid-up shares of any other Company, and the Directors shall give effect to such resolution, and, where any difficulty arises in regard to the distribution, they may settle the same as they think expedient, and in particular may issue fractional certificates, and may fix the value for distribution of such specific assets, or any part thereof, and may determine that cash payments shall be made to any members upon the footing of the value so fixed, in order to adjust the rights of all parties, and may vest any such specific assets in trustees upon such trusts for the persons entitled to the dividend as may seem expedient to the Directors.

Where requisite, a proper contract shall be filed in accordance with section 88 of the Companies (Consolidation) Act, 1908, and the Directors may appoint any person to sign such contract on behalf of the persons entitled to the dividend, and such appointment shall be effective."

Art. 128 provides for the formation of a reserve fund. The article numbered 127A was not passed until February 18, 1918, and it was confirmed on March 5, 1918, so that it does not directly affect the case in its operation. But it has been a good deal referred to in argument for the purpose of throwing light upon the nature of these transactions. Art. 127A is as follows:-

"127A.

The Company may at any time and from time to time in General Meeting by Resolution authorise the Directors to capitalise any profits of the Company not required for the time being for payment of Dividend upon any Preference Shares of the Company or other shares issued upon special conditions, whether standing to the credit of the Company's Reserve Fund or otherwise, and including profits arising from the appreciation in value of Capital Assets, and to allot to the members holding Ordinary Shares of the Company in respect of the net amount capitalised fully paid Shares of the Company of equivalent nominal amount, and the Directors shall give effect to any such Resolution accordingly, and any shares allotted pursuant to any such Resolution shall be distributed among the members holding Ordinary Shares of the Company so far as practicable in proportion to the number of Ordinary Shares held by them respectively, and shall be credited as fully paid by means of the profits so capitalised, and the Directors may make such provision by the issue of fractional certificates or by the payment of cash or by sale and distribution of the proceeds or otherwise as they may think expedient for the case of fractions."

The claim of the Crown to super-tax has been put in two ways:

(1.)

It was said that these transactions involved the payment of the dividend or bonus to the shareholders and that this rendered them liable to super-tax in respect of it, notwithstanding its return to the company in respect of the new shares issued.

(2.)

It was said that the allotment of the new shares amounted to a payment to the several shareholders of the dividends, though not in money but in money's worth.

The general scope and effect of these transactions is beyond dispute. There was an increase in the capital of the company by the retention of the amounts available for dividends. Though the number of shares was increased by the issue of the new preference shares to the ordinary shareholders, this did not affect the proportions to which they were entitled in the undertaking and in any profits.

All the shareholders received these new preference shares, so that the proportion in which they were to share in any profits remained the same. As the capital was increased it might reasonably be expected that the profits of the company would be increased, and that the shareholders would benefit in this way, but their relative shares in the undertaking remained the same. The use of the sums which had been available for dividend to increase capital would enable the company to carry on a larger and more profitable business, which might be expected to yield larger dividends.

These dividends, however, were to be in the future. So far as the present was concerned there was no dividend out of the accumulated profits; these were devoted to increasing the capital of the company. The company had power to do what it pleased with any profits which it might make. It might spend the accumulated profits in the improvement of the company's works and buildings and machinery. These improvements might lead to a great accession of business and increase of profits by which every shareholder would benefit, but of course it could not for a moment be contended that such a benefit would render him liable to super-tax in respect of it. The benefit would not be in the nature of income, and super-tax can be levied only on income. It would be so levied on the dividends afterwards received.

"It was, equally within the power of the company"

(I am using Lord Watson's words in Bouch v. Sproule) ^[F47]

"to capitalise these sums by issuing new shares against them to its members in proportion to their several interests."

This is what the company did in the present case. Art. 127A now enables them to do anything of this kind by a direct and simple process. Under it the directors may be authorized to capitalize any profits and to allot to the ordinary shareholders in respect of the net amount capitalized fully paid-up shares of the company of an equivalent nominal amount. This article, however, did not come into existence until 1918. It appears to me that there is no ground for saying that art. 127A is ultra vires. The company has power to capitalize these profits if it pleases, and such an article as this enables them to carry out the process of capitalization in a direct and simple fashion. But before art. 127A was passed the machinery for carrying out capitalization of profits had to be found in the other articles.

The article under which the capitalization was carried out in 1915 and 1916 was art. 127, which provides that any general meeting declaring a dividend may direct payment of it by the distribution of paid-up shares of the company, a proper contract, where necessary, being filed in accordance with s. 88 of the Companies (Consolidation) Act, 1908. The resolution of February 8, 1915, was, that for the purposes of capitalizing 33,333l. 6s. 8d., part of the undivided profits of the company, a bonus on each of the issued ordinary shares be declared, and that the directors be authorized to satisfy such bonus by the distribution among the members holding ordinary shares of 33,316 of the unissued second preference shares of 1l. each, credited as fully paid up.

The effect of this operation was that the amount of the bonus was retained by the company as additional capital, and that the shareholders got the new preference shares. No option was left to any particular shareholder. He was compelled by the action of the company to take the preference shares. He could not have sued for the bonus in money, as the resolution which gave the bonus uno flatu declared that it was to be satisfied by the distribution of preference shares. Under these circumstances it seems to me impossible to treat the shareholders for the purpose of super-tax as having received the bonus and paid it back to the company to be retained as capital. They never received it at all. The case appears to stand exactly as Rowlatt J. put it: ^[F48]

"Now I do not think that there is a payment of a dividend to a shareholder unless a part of the profits of the company is thereby liberated to him in the sense that the company parts with it, and he takes it. If, in this case, the company could have found means to capitalise their profits and divide them as capital without adopting the machinery of declaring a bonus and allotting shares by agreement (not, be it observed, a voluntary agreement) in satisfaction of such bonus, I do not think the case would have been arguable. I am asked to decide that there was a 'payment' of this bonus upon the strength of what I consider bare machinery. I cannot do so. The fact is simply that the shareholder was given shares instead of a bonus."

There can be no super-tax upon income unless it has been received by the taxpayer. I may be permitted to quote in this connection what was said by Pitney J. in Eisner v. Macomber, ^[F49] a case decided in the Supreme Court of the United States in March of last year. In dealing with the definition of "income" Pitney J., in delivering the opinion of the majority of the members of the Court in that case, said:

"Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being 'derived,' that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; that is income derived from property. Nothing else answers the description."

In the present case the bonus or so-called dividend was not severed from the capital; on the contrary, it was added to it. For these reasons it appears to me that the first contention of the Crown must fail.

The second contention of the Crown is that the allotment of the preference shares was equivalent to the payment of the bonus. To appreciate this point it is necessary to consider closely what it was that the shareholder got. Did he get anything in the nature of payment of income? It is obvious that he did not. He gave up any claim to the income. What might have been paid as income went to increase the capital of the company. The shareholder got his proportionate share in the business of the company as increased by the additional capital. The proportion of his share in that business as compared with the proportions of other shareholders was in no way affected by the issue of the preference shares, as all the shareholders alike got them.

The benefit, and the sole benefit, which the respondent derived was that the business in which he had a share was a larger one with more capital embarked in it, precisely as might have been the case if the accumulated profits had been applied in the improvement of the company's works and machinery. Instead of his getting any dividend, or anything in the nature of a dividend, the fund which might have been divided was impounded to increase the capital of the business. How is it possible to treat any advantage accruing from this as a payment of income? The case differs toto coelo from a case in which a dividend is paid not in money but in money's worth by the delivery, say, of goods or of securities. The preference shares are in themselves valueless.

They are merely part of the machinery for carrying out the capitalization, and if that capitalization could have been carried out without their issue the respondent would have been just as well off without them as he is with them. What he gained was that the business in which he had the same proportionate interest had become more valuable owing to the increase of capital. Super-tax cannot be levied on such an increase in the capital value of the business. It will be received from time to time on the larger dividend, which it is hoped will be yielded by the increase in the capital put into the business. How much of the profits earned in the business of a company should be divided among the shareholders is a matter of the internal management of the company which the shareholders must decide for themselves: Burland v. Earle. ^[F50]

They decided this matter for themselves in the present case and the preference shares were within the limits of the authorized capital of the company. They did not pay over the accumulated profits to the shareholders to enable them to pay up the new shares. They issued the new shares as fully paid up as representing the increase of capital which resulted from the detention by the company of the money which might otherwise have been paid as dividend. The contract filed under s. 88 of the Companies (Consolidation) Act, 1908, states that the new shares credited as fully paid up were to be taken in satisfaction of the bonus. If art. 127A had been in force in 1915 and 1916 the transaction would have assumed a simpler form, but the differences would have been one merely of machinery.

I now turn to the cases. Bouch v. Sproule ^[F51] was invoked by the respondent. On behalf of the Crown it was said that that case was one merely as between tenant for life and remainderman, and that it had no bearing on the question as to whether duty was payable to the Crown. It is, however, to be observed that the question in that case, which was decided in the House of Lords after very mature consideration by Lord Herschell, Lord Watson, Lord Bramwell and Lord FitzGerald, was, as Lord Herschell says, ^[F51] whether a certain bonus of 2l. 10s. per share was income of the estate of William Bouch the testator or was capital of that estate. It was held to be capital.

The question whether it was income or capital could not be affected by the purpose which led to the institution of the inquiry. The incidence of the taxation depends upon the question, What is in fact the nature of the property on which the tax is claimed? If it is income it is liable to tax upon income; if it is capital it is not so liable. The liability follows from the nature of the property, and it seems impossible to me to say that the answer to the question whether it is income or not is to depend upon the purpose with which the question is asked. The circumstances which gave rise to the case of Bouch v. Sproule ^[F51] are very like those in the present case.

They are stated at full length by Lord Herschell in his judgment. The Consett Iron Co. had a large amount standing to credit of reserve fund, and also an undivided profit fund. At a meeting of the company a resolution was passed for the payment of a bonus of 2l. 10s. per share out of the reserve fund and the undivided profit. A letter was sent to every shareholder enclosing a warrant and forms relating to the new shares. The letter to Sir T. Bouch, the trustee under the will of William Bouch, informed him that the directors had, in respect of his 600 shares, allotted to him 200 new shares of 10l. each subject to 7l. 10s. being paid upon them by September 30, and there was enclosed a bonus dividend warrant payable on that date for 1500l., with a request that it should be returned signed, when the amount would be applied in payment of the 7l. 10s. per share on the new shares. Sir T. Bouch signed the form acknowledging the receipt of the 1500l. and requesting that the amount should be applied in payment of the call of 7l. 10s. on the 200 new shares. Lord Herschell says: ^[F52]

"I think we must look both at the substance and form of the transaction. It is to be observed, in the first place, that the amount of that portion of the new capital created which was to be paid up was exactly equal to the amount of profits to be distributed. And it was obviously contemplated, and was, I think, certain that no money would, in fact, pass from the company to the shareholders, but that the entire sum would remain in their hands as paid-up capital";

and he says that he could not avoid the conclusion that the substance of the whole transaction was to convert the undivided profits into paid-up capital upon newly created shares. In that case it was held that the capital of the company was increased by these amounts and that they did not constitute income. All that Lord Herschell there says applies a fortiori to the present case. In Bouch v. Sproule ^[F53] there was a nominal option left to the shareholders as to the application of the bonus dividend. Lord Herschell held that this must be ignored, as it was nominal only and the circumstances showed it was never intended that it should be exercised. In the present case there was no option at all; the application of the bonus to increase of capital was compulsory. It was argued for the Crown that the 1500l. in the dividend warrant in Bouch v. Sproule ^[F53] would have been assessable to income tax, as it had been paid. I cannot agree. On the facts as found by the House of Lords the receipt of this money by the shareholder was merely formal. It was not to be retained, but handed over to the company to go in increase of capital. There never was any effective payment of this dividend as such.

Sir T. Bouch in receiving it acted as a mere conduit pipe for its transmission to the company to increase its capital. It was not received as income, but to be converted into capital of the company. In the present case there was no option at all, and there is no ground for saying that the bonus was ever received as income. The super-tax applies only to income and to income received in payment.

The case of The Swan Brewery Co. ^[F54] was much relied on by the Crown. I must, however, confess that the reasoning on which the judgment is rested appears to me to be inconsistent with the decision of this House in Bouch v. Sproule ^[F55] By that decision we are of course bound even if we had any doubt about its correctness. In the case of Eisner v. Macomber ^[F56] there is a most interesting and instructive judgment delivered by Pitney J. as representing five out of the nine members of the Court. There were two dissentients, Brandeis and Clarke JJ. Holmes and Day JJ., while dissenting on a point as to the construction of an amendment to the Constitution of the United States, concurred on the general question. That judgment is, of course, not binding on us as an authority, but it contains a most instructive review of the principles which have been discussed in the present case, and the conclusion, which was arrived at by seven out of the nine judges, is in entire harmony with that which appears to me to be the true view of the present case.

On these grounds I think that the present appeal ought to be dismissed.