Between: British Insulated and Helsby Cables Ltd - Appellants
And: Atherton - Respondent

Judges: Viscount Cave LC
Lord Atkinson
Lord Buckmaster
Lord Carson

Lord Blanesburgh

Subject References:
REVENUE
INCOME TAX
TRADE PROFITS
DEDUCTIONS
Lump Sum set aside out of Profits to establish Pension Fund for Employees
Trust Deed
'Money wholly and exclusively laid out .... for the purposes of the trade'
'Capital withdrawn from or any sum employed .... as capital in such trade'
Income or Capital Expenditure

Legislative References:
Income Tax Act, 1842 (5 & 6 Vict. c. 35), Rules applicable to Cases I. and II., r. 1 - s. 100, Sch. D, Case I., rr. 1 and 3

Judgment date: 11 December 1925

Judgment by:
Lord Blanesburgh

My Lords, it is, I apprehend, now well settled that in the Income Tax Acts, unless the context requires a different meaning to be placed upon them, such words as "profits," "gains," "capital," are to be construed according to their ordinary signification in commerce or accountancy. It will accordingly not be amiss if, remembering the nature of the present controversy, an attempt be made to ascertain from the statements or accepted implications of the stated case, but, in the first instance, merely as a business proposition, what was the precise nature and purpose of the payment now in question and, as consequent thereon, its proper place in this company's accounts.

Up to 1916 the clerical and technical staff of the company had no superannuation fund existent for their benefit. The lack of one had in practice proved disadvantageous to the company in several ways. With no continued provision in prospect for their old age, experienced members of its staff had been prone to leave the service for appointments elsewhere more attractive in this regard; and the natural anxiety of those who remained as to their financial position after retirement was not without its effect both upon their contentment and their efficiency. The existence of a pensions fund built up by their own contributions would assist, and if these contributions were supplemented by additions to be made to them by the company, would, it was expected, succeed in remedying this state of things. The fund would constitute a strong inducement to the individual contributories to remain during their working lives in the company's service, and it would tend to their increased efficiency while they so remained.

It was no part of the Attorney-General's case that this was not a reasonable expectation. That the company's action in this matter was prompted by anything more altruistic than an enlightened self-interest well calculated to secure for its business as a profit-earning concern and for itself as a good employer the advantages already indicated, the Attorney-General was not concerned to dispute.

Now, expenditure by a trading company of which so much can be affirmed is well within its powers, whether expressly so conferred or not. This is no longer doubtful. Indeed, since the case of Hutton v. West Cork Ry. Co., ^[F35] in which both the rationale of the power and its limitations are clearly expounded, this matter has ceased to be debatable. Modern conditions of industry have only tended to make the occasions for its exercise more frequent and more compelling. For myself, I cannot escape the conviction that, if the action of the company in this matter had been seen to be, as in my judgment it clearly is, no more than a striking illustration of the legitimate exercise of its inherent powers as in that judgment described, this case would have been shorn of much of the difficulty which it has presented to those who have regarded it from another angle.

In 1916 the pension which by means of the fund then in contemplation was to be provided for each participant on retirement at sixty-five was one-sixtieth of his average salary for every year of his service with the company. And there were to be other benefits. It was believed that if the contributions required of them were not made prohibitive, 300 at least of the company's then salaried staff would join a fund offering such advantages. It was, of course, of the essence of the scheme that in adequate numbers they should. Practical abstention on their part would have destroyed the whole raison d'tre of the fund so far as the company's participation in it was concerned. The necessity of securing their adhesion to it from the company's point of view explains the specially attractive terms which were offered them.

In the case, for instance, of future members of the staff who were to be required to join the fund as part of their contracts of service, only those under forty at the date of joining were under deduction from their salaries of so little as 5 per cent. to be entitled to the benefits of the fund. Not so the existing members of the staff. They were at that maximum cost to themselves and irrespective of age to be admitted as full participants; and, not only so, but their service with the company prior to the establishment of the fund and when, of course, no payments towards it were being made by them were to rank as pension years of service. Now, happily as many will think, the time has gone by when terms like these are, in such a connection, to be viewed even by a tax gatherer with jaundiced eyes. Here, however, it is not even suggested that they were more attractive than the occasion required. They could not, however, without a contribution to the fund made specially on account of these employees have been fulfilled. A fund composed alone of the proposed future contributions and offering these benefits would from its very inception have been actuarially insolvent.

The contribution of 31,784l., with which your Lordships are now concerned, was the payment actuarially calculated to be requisite, and it was in the event by the company made, to avoid that result.

On August 8, 1916, the company executed the trust deed constituting the fund, and it thereby covenanted with the trustees to make the following payments:

(a)

The sum now in question;

(b)

An annual contribution aggregating one-half of every sum in the same year contributed by each participant employee;

(c)

A contribution sufficient to make the annual return upon the invested moneys of the fund one of 4 per cent.

This third contribution does not enter into the argument and need not again be referred to. With reference to the other two, however, it is well nigh vital to ascertain what they really represented and what under the trust deed was the duty of the trustees in relation to them when received.

The sum with which your Lordships are immediately concerned, this 31,784l., represented the actual equivalent of the sum with accretions of interest which would at the date of the establishment of the fund have been in the hands of its trustees if there had in fact been made by or on account of each of these participant members during each of the previous years of service for which he was to rank for pension the payments which would have been called for had the fund then existed. It was a payment by the company on account of each of these employees of a sum which in the language of the Master of the Rolls in Rowntree's case ^[F36] comprised and compressed a series of prior annual payments on his account. It was a sum, and this is perhaps in the present connection its most important characteristic, actuarially so adjusted in amount that when the last of the existing staff, participant to the fund, on whose account it had been paid died or fell out of benefit no part of it or of any accretion to it would remain in the hands of the trustees. It would then have been entirely exhausted in providing the covenanted benefits for the participants on whose account it was paid. It is as if the company, as it might well have done, had paid this money to the trustees of a pension fund, otherwise identical in its provisions and benefits with that constituted, but in which only then existing members of the staff were to be participant. On the death of the last of these the trustees actuarially would be left with no funds at all. In no sense was this 31,784l. the permanent capital of any fund.

As to the annual contributions made, as these were to be, on account of every participant member of the fund, present and future, what is important to note about them is that it was the duty of the trustees, as with the first sum, to invest and accumulate them when received so far as they were not required to meet current outgoings of the fund. In other words, there was to be no distinction at all between the way in which the trustees were to deal with payment (a) and with payments (b) when made and received. All contributions received by them became, on receipt, indistinguishably blended.

My Lords, if what I have so far said be accurate, it follows that in no relevant respect do these payments (a) and (b) differ from one another. What, then, is the outstanding characteristic of all of them? It is, I think, this, that they are made by the company for the account, as to the first payment, of some, as to the later payments, of all of its participant staff employees; made, it is true, in a special form to secure a special end, but, from the company's side, when regard is had to their purpose, made with the same justification that would attend the payment of an increased remuneration of the individual employees benefited. Regard, in retrospect, after his retirement, the proportion of these payments made by the company on account of any individual participant. In no material respect, quoad the company, do they differ from any payments of salary made to him direct. In truth, we have here a much plainer case than that of Hancock. ^[F37] There the payment was made in respect of an officer who had retired. The main justification suggested for it was the protection of the company against recurrent demands. Here the payments are made on account of officials still in the service, and are made that that service may be more contented, more efficient and more prolonged. Can any higher warrant than this for the payment of any staff salary be suggested?

And it is admitted by the Crown that the company's periodical contributions (b) are all of them properly chargeable to revenue account. But why so? Surely, because they are not only, as I have, I hope, shown, legitimate payments, but because, as such, they are none other than expenses prudently incurred in the course of the company's business. And such, too, is payment (a) - this sum of 31,784l. Payments (b) are additional remuneration for every one of the participant members of the fund, proportioned in each case to his own contribution to it. Payment (a) is still further remuneration in no way commercially excessive for those of them who when the fund was established were already in the company's service, and proportioned in each case to the amount of his salary for the time being.

I do not myself see how any of these payments could properly be charged to capital account by any company which keeps its accounts on the double account system. And as the Income Tax Acts contemplate that accounts will be so kept, no other system need here be considered. Under that system, as is well known, the two accounts, capital and revenue, or trading account, as in business language it is usually termed, are separate accounts. The capital account is concerned with the company's fixed capital and its application. The revenue account is concerned with the company's trading or circulating capital and its application. Dividends may lawfully be paid, although, it may be, the whole of the company's fixed capital has disappeared. No profits available for dividend are, however, existent, unless the company's trading capital would remain intact after they had been distributed as such. If what I have so far said be correct, it follows that for this company to have charged any of these payments, either (a) or (b), to capital account would have thrown on that account a revenue charge; would have enabled the company to ascertain profits and distribute dividends without taking it into account; would have introduced a system facilitating in the case of a company less prosperous the concealment, more or less successful, of the truth, that dividends declared during a period of depression were in whole or in part being paid out of capital.

My Lords, on the facts of this case there were, as it seems to me, only three funds from which any of these payments (a) or (b) could, by such a company as this, legitimately have been taken. The first was its undistributed profits - the payments, if thence derived, being no more than a series of bonuses to its employees out of the realized profits of good years. The second was its gross receipts before profits were struck. The third, merely another aspect of the second, and not applicable to this prosperous company, was working capital to which recourse might properly be had on any occasion when the gross receipts after these payments had been charged against them were less than the outgoings by at least an equivalent amount.

Applied to this company, on the facts found, there is, as to the first of these no suggestion of any intention on its part to make these payments out of realized profits. The unqualified covenant into which it entered with regard to them would have effectively disposed of such a suggestion had it been made.

As to the third the gross receipts, as I have indicated, were more than adequate to meet the payment and still leave a large surplus.

The revenue account, therefore, strictly so called, alone remains as the place in which they can properly appear.

As to the suggestion that the 31,784l. representing the notional payments made over a number of years must be treated as capital because that sum was paid in one year and in one amount, I find myself in entire agreement with Lush J., when in Hancock v. General Reversionary and Investment Co. ^[F38] he said:

"It seems to me as impossible to hold that the fact that a lump sum was paid instead of a recurring series of annual payments alters the character of the expenditure as it would be to hold that, if an employer made a voluntary arrangement with his servant to pay the servant a year's salary in advance instead of paying each year's salary as it fell due, he would be making a capital outlay."

For these reasons, I cannot bring myself to doubt that this payment of 31,784l., judged of purely as a commercial transaction of this company and not purporting or intended to be a bonus out of profits, could only properly be brought into charge, as in fact it was, in the revenue account of the company.

And if this be the true conclusion, apart from the Income Tax Acts, the propriety of this payment as an admissible deduction in the ascertainment of the balance of the company's profits and gains under these Acts follows, I think, almost as of course.

My Lords, I will substitute for any re-statement of the relevant provisions of the statutes, already well under your Lordships' notice, two authoritative pronouncements as to their effect.

"Profits and gains,"

said Lord Loreburn, in the case of Usher, ^[F39]

"must be estimated on ordinary principles of commercial trading by setting against the income earned the cost of earning it, subject to the limitations prescribed by the Act."

"The effect .... I think, is this,"

said Lord Sumner in the same case,

"that the direction to compute the full amount of the balance of the profits must be read as subject to certain allowances and to certain prohibitions of deductions, but that a deduction, if there be such, which is neither within the terms of the prohibition nor such that the expressed allowance must be taken as the exclusive definition of its area, is to be made or not to be made according as it is or is not, on the facts of the case, a proper debit item to be charged against incomings of the trade when computing the balance of profits of it."

To these I will add three further statements as to the true result of the Act in matters relevant to the present discussion.

The first, justified by reference both to Usher's case ^[F40] and to the judgment of Lord Dunedin, when Lord President, in the Vallambrosa case, ^[F41] is that the fact that expenditure in question is not referable to the profits of the year in which it is made does not prevent it from being a proper deduction in that year. The second, justified also by Usher's case, is that the admissibility of a deduction under the Act is not dependent upon the question whether at the time the payment was made the subject was under legal liability to make it. Payments, justifiable on the principle of Hutton's case ^[F42] already cited, are well within the limits of admissibility. The third, justified by some observations in the judgment of Scrutton L.J. ^[F43] in the present case which command my entire concurrence, is that the reference in r. 3 of Case I. in s. 100 of the Act of 1842 to "capital" withdrawn from or employed in the trade is a reference to fixed capital, as distinct from "circulating" or, in Lord Watson's phrase, "trading" capital, the proper source for payment of wages and other expenses incurred in the conduct of a trader's business: see Gresham Life Assurance Society v. Styles. ^[F44]

Bearing these authoritative considerations in mind, I proceed now to apply the relevant prohibitions of the Acts to this payment, and I ask myself first whether there is any ground for affirming that this money was not laid out or expended wholly and exclusively for the purposes of this company's trade, manufacture, adventure or concern? The answer must, I think, be in the negative. The explanation already given of the circumstances in which, and the object for the attainment of which, the payment was made leaves no doubt in my mind on this point, and I believe all your Lordships take the same view. I notice that the Master of the Rolls, for the purpose of his judgment only, and clearly with some reluctance, accepts it. I am myself unable to share his reserve.

I next ask myself whether it is true to say that this payment represented "capital withdrawn from or any sum employed or intended to be employed as capital" in the company's trade? Again, I think the answer must be in the negative. Mr. Hills, in his able argument on behalf of the Crown, while disclaiming any desire to attach too much weight to the contention, found in cl. 3 (A) of the trust deed of the fund, by which the company covenanted to pay this sum to the trustees "in order to provide the capital sum necessary in order that past years of service of the present permanent staff since they received a salary of 100l. per annum or more shall rank for pension," an indication that this was on the part also of the company a payment on capital account. The suggestion strikes me as novel. I cannot myself see how that which really is a revenue payment on the part of the trader making it - whether it is so or not is of course a question - can become a capital disbursement merely because the recipient invests it or, if you like, agrees to invest it, any more than I can see how that which was a capital payment on the part of the payer becomes a revenue payment merely because the recipient spends it or is left at liberty to spend it. Moreover, the application of this principle to the present case would, in view of the terms of this trust deed, equally extend to the company's periodic payments all of which the Crown agrees and even asserts are properly chargeable to revenue.

And the difficulty of treating this as a capital disbursement of the company is appreciated when the divergent grounds on which the Master of the Rolls and Scrutton L.J. held it so to be are regarded. In the view of the Master of the Rolls this payment not being "a necessary expenditure in seeking profits and gains," was only made at all because the company had a good year; if they had had a bad year they would not have made it, "still less would they have charged it on ordinary principles to the revenue account" .... "therefore .... it ought to be treated as being an item of capital to be employed as capital in such trade." My Lords, I demur in limine to the statement that a disbursement to be admissible as a deduction must be a "necessary" expenditure in seeking profits. Usher's case ^[F45] I think clearly indicates that it suffices, in this regard, if it be prudent in the proper and reasonable conduct of the trade. One has only to recall in this connection advertising expenditure. But, my Lords, even if the premises be conceded I cannot myself see that the conclusion follows. The learned Master of the Rolls might, possibly, consistently with his premises have well held that this payment was in truth a bonus out of realized profits and not an expense incurred with a view of maintaining them in the future. That, however, was not open to him on the case stated. That these premises lead to the conclusion that the payment is one either withdrawn from or to be employed as capital - as fixed capital bien entendu - seems to me to be quite inadmissible.

Scrutton L.J., to whose views as to the meaning of the word "capital" in the statute I have already referred, holds that the sum should be disallowed, because as a result of the expenditure "either capital was withdrawn from the business for this pension fund or the capital employed in the business created an asset or advantage of the business" - by which expression, as the Lord Justice explains in another part of his judgment, he means "something in the nature of fixed capital." Now, my Lords, this method of arriving at the same result as the Master of the Rolls is, in my judgment, equally open to destructive criticism. In no sense of the word "capital," circulating, working or fixed, did this expenditure involve any withdrawal. It was made out of gross receipts in a year in which, working capital and, a fortiori , fixed capital, remaining intact, a large surplus still emerged. Nor, in my judgment did the expenditure in any relevant sense create a new asset of the company of the nature of a fixed capital asset or any other. The learned Lord Justice does not more closely describe this so-called asset or, fixed though it was, did he attach to it a name by which it could be recognized. He did not suggest that it resulted in an enhanced goodwill. He could not, in my judgment, have done so with reason, because it has never, I think, even been suggested that a contented personnel is an element in goodwill, whatever else it may be. In that state of things it has occurred to me, my Lords, that the existence or non-existence of this so-called asset might fairly be submitted to the prosaic test of asking what in a liquidation would be forthcoming in respect of it when a liquidator essayed his statutory duty to realize the company's assets and divide the proceeds amongst his constituents. Certainly no part of the fund. That in its entirety is completely alienated. And I can myself think of nothing else.

Moreover, my Lords, a reference to the authorities shows, it seems to me, clearly that it is by reference to no such shadowy conceptions that the words of the statute "employed as capital" have to be interpreted. Such things as a purchase of goodwill involving a capital expenditure might come within them: Smith & Son v. Moore, ^[F46] an excess profits duty case. The expense of making a new channel to the sea essential or convenient for approach to a shipyard would be such expenditure, notwithstanding that the channel when constructed would not be the property of the trader and that others jointly with himself would have the right to use it on their lawful occasions: Ounsworth v. Vickers, Ld. ^[F47] The expenses incurred in the promotion of a private Bill the capital object of which was ultimately obtained by agreement: Moore & Co. v. Hare. ^[F48] These advantages are real and definite. I can see nothing comparable here. Moreover, in this connection also the observation already made is true that the principle expounded by the Lord Justice would equally apply to the annual payments to be made by the company, and admittedly properly chargeable to revenue.

The result, therefore, is that, in my judgment, there is so far no prohibition in the statute which prevents, for the purposes of income tax, the application to this disbursement of the principles which for any other purpose are alone, as I think, properly applicable to it. And no other statutory prohibition is suggested.

Warrington L.J.'s ground of decision against the appellants is quite different. He would, I think, as I have done, have answered in the negative the two questions already propounded. It is, at any rate, consistent with his judgment that he would have done so. His decision for the Crown is based solely on the ground that in his judgment the payment in question was, in Lord Sumner's words already quoted, "not a proper debit item to be charged against incomings of the trade when computing the balance of profits of it." The learned Lord Justice treats these words of Lord Sumner's as extending to a revenue disbursement wholly and exclusively laid out or expended for the purposes of the trade, which is, nevertheless, still inadmissible as a deduction because it is not a proper debit item to be charged. I agree with the Lord Justice in thinking that the words do import all that. But what amount of impropriety is to be treated as sufficient to require disallowance as improper of a disbursement which is not the subject of, at all events, express statutory prohibition? It must surely be an expenditure somewhat abnormal or irrational or extravagant. I conceive, for instance, that a payment avowedly made out of realized profits such as is alluded to by Lord Dunedin in another portion of his judgment in the Vallambrosa case ^[F49] would clearly be within the words. I doubt, however, whether the learned Lord Justice would have brought the present disbursement within the same category had there been present to his mind the extraordinarily compelling circumstances which, as a matter of business, had led to it. These properly regarded - I do not again detail them - and the payment treated - on this hypothesis it must be - as a revenue payment, it seems to me impossible to hold that it was in any sense at all either excessive or improper.

My Lords, I need not expand a judgment already too long by any further discussion of the authorities. I think with the Lord Chancellor that Hancock ^[F50] was correctly decided, but I should myself have been prepared to decide this case as I do even if I were of opinion that Hancock could not be supported - so much more compelling in a relevant respect are the facts and circumstances here. As to Rowntree ^[F51] the disbursement there sought to be justified came, in my judgment, both within the express prohibition of the statute and its implied prohibition as enunciated by Lord Sumner.

On the whole case I am of opinion that the order of the Court of Appeal should be reversed and that of Rowlatt J. restored.

Order of the Court of Appeal affirmed, and appeal dismissed with costs.

Lords' Journals, Dec. 11, 1925.

Solicitors for the appellants: Rawle, Johnstone & Co., for Hill, Dickinson & Co., Liverpool.

Solicitor for the respondent: Solicitor of Inland Revenue.