Van den Berghs Ltd v Clark (Inspector of Taxes)
[1935] A.C. 431(Decision by: Lord MacMillan)
Between: Van den Berghs Ltd - Appellant
And: Clark (Inspector of Taxes) - Respondent
Judges:
Lord Atkin
Lord Tomlin
Lord Russell of Killowen
Lord MacMillanLord Wright
Subject References:
REVENUE
INCOME TAX
Agreement between Trade Rivals
Sum paid to terminate
Capital or Profits of Trade
Legislative References:
Income Tax Act, 1918 (8 & 9 Geo. 5, c. 40) - Sch. D, Case 1
Judgment date: 8 April 1935
Decision by:
Lord MacMillan
My Lords, in the year 1927 the appellants received payment of a sum of 450,000l. from Anton Jurgens Vereenigde Fabrieken of Holland (whom I shall call "the Dutch Company") pursuant to the terms of an agreement between the appellants and the Dutch Company dated September 24, 1927. The question is whether this sum ought to be taken into account in computing the balance of the profits or gains of the appellants' trade for the year on which they are chargeable to tax for the year 1928-29 under Sch. D of the Income Tax Act, 1918.
The appellants say that the 450,000l. was a capital receipt and ought not to be reckoned as forming any part of the profits arising from the carrying on of their trade. The Crown says that the 450,000l. was a trade receipt which ought to be included in the computation of the appellants' profits or gains for income tax purposes.
The circumstances in which the appellants received the payment which has now to be examined are set out in the stated case, from which I select the salient facts.
The appellants were incorporated as a limited company in this country in 1895 and have since carried on the business of manufacturing and dealing in margarine and similar products on a very extensive scale both here and abroad. They had as their keenest competitors the Dutch Company, which was engaged in the same business in Holland. On February 13, 1908, the two companies entered into an agreement whereby they bound themselves for the future to "work in friendly alliance" and to share their profits and losses in conformity with an elaborate scheme detailed in the agreement.
Each of the two companies had a controlling interest in a number of other companies and they undertook that, if either of them or any of the companies which they controlled should acquire an interest in any other margarine concern, the fact should be communicated to the other party, who should have an option to require that interest to be brought within the operation of the agreement. Both companies further undertook on behalf of themselves and of their controlled companies not to enter into any pooling or price arrangements with third parties which might be deemed inimical to the interests of the two companies under the agreement. The directors and managers of the respective companies were parties to the agreement and bound themselves for twenty years not to engage in any margarine business other than that of the two companies. Provision was also made for the setting up of a representative joint committee which was empowered to make arrangements with outside companies and firms as to the selling and buying prices of margarine and the limitation of areas of supply. It was further comprehensively agreed that
"each of the two companies shall be true and loyal to the other of them and shall do all in the power of such company to promote the commercial, technical, pecuniary, buying and selling and other interests of the parties hereto in relation to the margarine business."
It is not necessary to set out the detailed provisions of the agreement, but its elaborate character is sufficiently indicated by the fact that it consists of 35 articles (with numerous sub-heads) and five schedules and extends to 22 pages of print in the case before your Lordships.
A supplemental agreement was entered into between the parties on July 17, 1913, which recited that the Dutch Company had acquired rights in a process for hardening oils and that the parties were desirous of formulating a scheme for the merger of their assets or the unification of their financial and commercial interests and for the regulation and allocation of their turnover, but that such a scheme could not at present be fully elaborated to their satisfaction, and it was desirable in the meantime to regulate their mutual relations and modify and extend the principal agreement in the manner provided in the supplemental agreement.
By this second agreement the parties modified the original basis of ascertaining and sharing profits and subject thereto agreed to continue in force the relative provisions of the principal agreement until December 31, 1940. Provision was made for the formation of a committee to endeavour to devise the scheme of merger or unification mentioned in the recital, and, failing agreement upon such a scheme by December 15, 1913, the parties bound themselves to execute a contract confirming and extending to December 31, 1940, the provisions of the supplemental agreement and of a scheduled document setting out agreed alterations in their existing pool contract.
According to the stated case
"each company carried on its business independently, but in general the parties observed the terms of the said agreements for each of the years 1908 to 1913 and the profits of the two companies were accounted for for those years. Payments were in fact made by and to the appellants under the said agreements in these years. The payments made to the Dutch Company were deducted as an expense and those made by the Dutch Company were brought in as a receipt in making up the appellants' profit and loss accounts for the years in which the payments were made or received.
In computing the appellants' income tax liability for the said years the amounts of such payments or receipts were deducted or brought into the taxable profit respectively, and the income tax was paid accordingly. It was also agreed by the appellants, when liability for income tax and excess profits duty was under consideration for years subsequent to 1913, that the results of working the said agreements should be charged to income tax and excess profits duty as trading receipts and payments."
During the war the two companies did not operate the agreements, and after peace was restored they found it desirable to enter into a fresh agreement in an endeavour to render workable the two previous agreements which were then running and would not terminate till 1940. This third agreement, which was dated October 15, 1920, recited that some of the provisions of the previous agreements had become obsolete or impracticable. It then proceeded to provide that, subject to the amendments and additions thereby effected, the principal agreement should remain in force till December 31, 1940. Further provision was made for the mutual communication of information relating to manufacturing processes, the basis of the ascertainment and division of profits was modified, the branches of business embraced were extended, and various other matters were regulated. As in the case of the two previous agreements, all disputes were referred to arbitration.
Meantime the appellants had been endeavouring to estimate the sum which they believed had accrued due to them by the Dutch Company over the war period. After various tentative calculations they brought out in 1922 a sum of 449,042l., which they alleged was owing to them. The Dutch Company disputed this figure and claimed that on the contrary the appellants were on balance indebted to them. The matter went to arbitration in 1925. The proceedings dragged on inconclusively at "prodigious" [F1] expense until in 1927 the parties came to an arrangement which was embodied in three agreements all dated September 24, 1927.
By the first of these agreements the members of the Jurgens family and the members of the Van den Bergh family agreed to consolidate their respective interests in a Dutch holding company and an English holding company on the terms therein mentioned.
By the second of these agreements each party withdrew all claims against the other party under the agreements of 1908, 1913 and 1920 for the years 1914 to 1927 inclusive, and both parties mutually discharged each other from any liability arising thereunder before December 31, 1927. Each party further undertook to do everything necessary to put an end to the arbitration.
The third of these agreements recited that the Dutch Company had expressed to the appellants a desire to determine the agreements of 1908, 1913 and 1920 contrary to the provisions therein contained, and that the appellants had consented thereto in consideration of the payment to them by the Dutch Company of 450,000l. "as damages." This agreement consists of two articles only. By the first article the parties agreed that the three agreements of 1908, 1913 and 1920 should be thereby determined as from December 31, 1927, and each party released the other party from all claims thereunder. By the second article the Dutch Company undertook forthwith to pay to the appellants a sum of 100,000l. and to hand to them promissory notes for a further sum of 350,000l. payable as therein stated. In point of fact the total sum of 450,000l. was paid in cash by the Dutch Company to the appellants before the expiry of the year 1927. This is the sum in dispute in the present appeal.
The Special Commissioners held that "the 450,000l. was paid in respect of the pooling agreements and must be brought in for the purpose of arriving at the balance of profits and gains of the appellants for the year ending December 31, 1927." That is their sole finding; it is not informative, for everyone agrees that the sum in question was paid "in respect of the pooling agreements," but there can be no doubt, if regard be had to the contentions submitted to them, that the Commissioners, view was that the sum in question was an income receipt.
Finlay J. reversed the determination of the Special Commissioners, and held that the agreements which were cancelled were "a capital asset" of the appellants and that the 450,000l. was "not an income receipt at all." The Court of Appeal unanimously reversed this judgment and restored the determination of the Special Commissioners, holding that the sum was not received by the appellants in consideration of the surrender of a fixed capital asset but arose from a transaction attributable to circulating capital, and was consequently an income receipt.
My Lords, the problem of discriminating between an income receipt and a capital receipt and between an income disbursement and a capital disbursement is one which in recent years has frequently engaged your Lordships' attention. In general the distinction is well recognized and easily applied, but from time to time cases arise where the item lies on the borderline and the task of assigning it to income or to capital becomes one of much refinement, as the decisions show. The Income Tax Acts nowhere define "income" any more than they define "capital"; they describe sources of income and prescribe methods of computing income, but what constitutes income they discreetly refrain from saying. Nor do they define "profits or gains"; while as for "trade", the "interpretation" section of the 1918 Act only informs us, with a fine disregard of logic, that it "includes every trade, manufacture, adventure or concern in the nature of trade." Consequently it is to the decided cases that one must go in search of light. While each case is found to turn upon its own facts, and no infallible criterion emerges, nevertheless the decisions are useful as illustrations and as affording indications of the kind of considerations which may relevantly be borne in mind in approaching the problem.
The reported cases fall into two categories, those in which the subject is found claiming that an item of receipt ought not to be included in computing his profits, and those in which the subject is found claiming that an item of disbursement ought to be included among the admissible deductions in computing his profits. In the former case the Crown is found maintaining that the item is an item of income; in the latter, that it is a capital item. Consequently the argumentative position alternates according as it is an item of receipt or an item of disbursement that is in question, and the taxpayer and the Crown are found alternately arguing for the restriction or the expansion of the conception of income.
I propose to refer first to the case of British Insulated and Helsby Cables, Ld. v. Atherton. [F2] This case has been generally recognized as the leading modern authority on the subject, though I fear that Romer L.J. was unduly optimistic when he said that it "placed beyond the realms of controversy" the law applicable to the matter: Anglo-Persian Oil Co. v. Dale. [F3] The facts were that the appellant company claimed to deduct in the computation of its trade profits a sum which it had provided to form the nucleus of a pension fund for its employees. The Crown argued that the sum ought to be debited to capital on the ground that it "was not in its nature recurrent but was made once for all" and that it was a case of the "provision of a capital sum which will for ever after relieve the company from making any further payment whatsoever."
This argument prevailed. The Lord Chancellor (Viscount Cave) found in the decisions "considerable authority" for the view which he recommended to the House to adopt - namely, that
"when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade .... there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital." [F4]
Lord Atkinson [F5] indicated that the word "asset" ought not to be confined to "something material" and, in further elucidation of the principle, Romer L.J. has added that the advantage paid for need not be "of a positive character" and may consist in the getting rid of an item of fixed capital that is of an onerous character: Anglo-Persian Oil Co. v. Dale. [F6]
My Lords, if the numerous decisions are examined and classified, they will be found to exhibit a satisfactory measure of consistency with Lord Cave's principle of discrimination. Certain of them relate to excess profits duty and not to income tax, but for the present purpose this distinction is immaterial. A sum provided to establish a pension fund for employees, as has already been seen, is a capital disbursement: British Insulated and Helsby Cables, Ld. v. Atherton; [F7] so is a sum paid by a coal merchant for the acquisition of the right to a number of current contracts to supply coal: John Smith & Son v. Moore; [F8] so is a payment by a colliery company as the price of being allowed to surrender unprofitable seams included in its leasehold: Mallett v. Staveley Coal & Iron Co. [F9] Similarly a sum received by a fireclay company as compensation for leaving unworked the fireclay under a railway was held to be a capital receipt: Glenboig Union Fireclay Co. v. Commissioners of Inland Revenue. [F10]
On the other hand, a sum awarded by the War Compensation Court to a company carrying on the business of brewers and wine and spirit merchants in respect of the compulsory taking over of its stock of rum by the Admiralty was held to be a trade or income receipt: Commissioners of Inland Revenue v. Newcastle Breweries, Ld.; [F11] so was a sum paid to a shipbuilding company for the cancellation of a contract to build a ship: Short Brothers, Ld. v. Commissioners of Inland Revenue; [F12] so was a lump sum payment received by a quarry company in lieu of four annual payments in consideration of which the company had relieved a customer of his contract to purchase a quantity of chalk yearly for ten years and build a wharf at which it could be loaded: Commissioners of Inland Revenue v. Northfleet Coal and Ballast Co.; [F13] so was a sum recovered from insurers by a timber company in respect of the destruction by fire of their stock of timber: J. Gliksten & Son v. Green. [F14]
Conversely, where a company paid a sum as the price of getting rid of a life director, whose presence on the board was regarded as detrimental to the profitable conduct of the company's business, the payment was held to be an income disbursement: Mitchell v. R. W. Noble, Ld.; [F15] so was the payment made in the case of the Anglo-Persian Oil Co. v. Dale [F16] in order to disembarrass the company of an onerous agency agreement. There are further instances in the reports, but I have quoted enough for the purposes of illustration.
With the guidance thus afforded I now address myself to the question whether the 450,000l. received by the appellants in the circumstances already narrated can properly be described as an item of profit arising or accruing to them from the carrying on of their trade, which ought to be credited as an income receipt. It is important to bear in mind at the outset that the trade of the appellants is to manufacture and deal in margarine, for the nature of a receipt may vary according to the nature of the trade in connection with which it arises. The price of the sale of a factory is ordinarily a capital receipt, but it may be an income receipt in the case of a person whose business it is to buy and sell factories.
My Lords, the learned Attorney-General stated that he was content to take the agreements of 1927 as meaning what they say. The sum of 450,000l. is accordingly to be taken as having been paid by the Dutch Company to the appellants in consideration of the appellants consenting to the agreements of 1908, 1913 and 1920 being terminated as at December 31, 1927, instead of running their course to December 31, 1940. If the payment had been in respect of a balance of profits due to the appellants by the Dutch Company for the years 1914 to 1927, different considerations might have applied, but it is agreed that it is not to be so regarded.
Now what were the appellants giving up? They gave up their whole rights under the agreements for thirteen years ahead. These agreements are called in the stated case "pooling agreements," but that is a very inadequate description of them, for they did much more than merely embody a system of pooling and sharing profits. If the appellants were merely receiving in one sum down the aggregate of profits which they would otherwise have received over a series of years the lump sum might be regarded as of the same nature as the ingredients of which it was composed. But even if a payment is measured by annual receipts, it is not necessarily itself an item of income. As Lord Buckmaster pointed out in the case of the Glenboig Union Fireclay Co. v. Commissioners of Inland Revenue: [F17]
"There is no relation between the measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of the test."
The three agreements which the appellants consented to cancel were not ordinary commercial contracts made in the course of carrying on their trade; they were not contracts for the disposal of their products, or for the engagement of agents or other employees necessary for the conduct of their business; nor were they merely agreements as to how their trading profits when earned should be distributed as between the contracting parties.
On the contrary the cancelled agreements related to the whole structure of the appellants' profit-making apparatus. They regulated the appellants' activities, defined what they might and what they might not do, and affected the whole conduct of their business. I have difficulty in seeing how money laid out to secure, or money received for the cancellation of, so fundamental an organization of a trader's activities can be regarded as an income disbursement or an income receipt. Mr. Hills very properly warned your Lordships against being misled as to the legal character of the payment by its magnitude, for magnitude is a relative term and we are dealing with companies which think in millions. But the magnitude of a transaction is not an entirely irrelevant consideration. The legal distinction between a repair and a renewal may be influenced by the expense involved. In the present case, however, it is not the largeness of the sum that is important but the nature of the asset that was surrendered. In my opinion that asset, the congeries of rights which the appellants enjoyed under the agreements and which for a price they surrendered, was a capital asset.
I have not overlooked the criterion afforded by the economists' differentiation between fixed and circulating capital which Lord Haldane invoked in John Smith & Son v. Moore [F18] and on which the Court of Appeal relied in the present case, but I confess that I have not found it very helpful. Circulating capital is capital which is turned over and in the process of being turned over yields profit or loss. Fixed capital is not involved directly in that process, and remains unaffected by it. If this is to be the test, I fail to see how the appellants could be said to have been engaged in turning over the asset which the agreements in question constituted. The agreements formed the fixed framework within which their circulating capital operated; they were not incidental to the working of their profit-making machine but were essential parts of the mechanism itself. They provided the means of making profits, but they themselves did not yield profits. The profits of the appellants arose from manufacturing and dealing in margarine.
For these reasons I am of opinion that the judgment of the Court of Appeal should be reversed with costs and the judgment of Finlay J. restored.