Inland Revenue Commissioners v Oswald
[1945] A.C. 360(Judgment by: Lord Porter)
Between: Inland Revenue Commissioners
And: Oswald
Judges:
Lord Thankerton
Lord Russell of Killowen
Lord MacMillan
Lord PorterLord Simonds
Subject References:
REVENUE
INCOME TAX
Mortgage of reversionary interest
Capitalization of mortgage interest
Falling in of reversion
Income tax in respect of capitalized interest
Legislative References:
Income Tax Act, 1918 (8 & 9 Geo. 5, c. 40) - All Schedules Rules, r. 21
Judgment date: 19 April 1945
Judgment by:
Lord Porter
(Read by Lord Simonds:) My Lords, the mortgagee's trustees claimed that there was owing to them a sum of 8,301l. 8s. 2d., and this they calculated firstly by taking simple interest on the 3,100l. from August 18, 1906, to May 18, 1935, deducting the appropriate amount of income tax due from year to year and capitalizing the balance and adding it to the original debt and secondly, by treating the sum so capitalized in a similar manner up to August 18, 1938, and then capitalizing the balance of interest as before. After that date interest less tax is charged on the final sum so capitalized but no further capitalization is resorted to. Some question was raised by the Crown as to whether the capitalization was rightly calculated, and whether the gross sum of interest without deducting the appropriate amount of tax should not have been included in the final amount instead of the nett amount less tax, but whichever principle is adopted the sum available for answering the debt is less than what is due and having regard to the view which I hold it is unnecessary to consider which calculation is the correct one. In either event the mortgagee's trustees will get less than the sum they are owed. The inland revenue authorities claimed that before making payment to the mortgagee's trustees the respondent ought to deduct and pay income tax on the interest capitalized as aforesaid and on the interest on that interest. The mortgagee's trustees disputed this contention.
The question therefore arises whether the respondent on paying the principal sum due was under an obligation to deduct some and what sum to answer the claim of the Crown for income tax. The solution depends primarily on the construction of r. 21 of the General Rules applicable to schedules A, B, C, D and E, which are contained in the First Schedule to the Finance Act, 1918. Leaving out unnecessary expressions, that rule runs as follows:
- "(1.)
- Upon payment of any interest of money. ... not payable. ... out of profits or gains brought into charge the person by or through whom any such payment is made shall deduct thereout a sum representing the amount of the tax thereon at the rate of tax in force at the time of the payment."
Sub-r. 2 enacts that the person so deducting shall forthwith render an account to the commissioners of the amount so deducted. The deduction is to be made "upon payment" and similarly r. 19 which deals with annual payments out of profits or gains brought into charge to tax permits deduction on making the payment, though in that case the deduction is optional, not compulsory, and the deduction is of tax at the rate or rates of tax in force during the period through which the payment was accruing due, not at the rate in force at the time of payment. In each case, if the deduction is made, its maker is assessed on the amount so deducted. The Crown in these circumstances contended that the compulsory deduction required by the statute could only take place at the moment when actual payment was made to the mortgagee's trustees and that the appropriate sum to be deducted was a sum equivalent to tax at the rate then in existence on so much of the fund as was rightly appropriated to interest (including capitalized interest).
The respondent, as I understood, agreed that tax was deductible only on Payment, but said that the capitalization of interest under the terms of the mortgage deeds amounted to payment as each sum of interest became due, or at any rate at the date of capitalization, and that in making this payment the tax must be taken to have been deducted, by those who made the payment, at the rate then due. He went on to contend that the payment must be taken to have been made as and when the interest became due by the person then owing the interest and that this was either Mrs. Beyfus or those representing her estate and was not, at any rate until after the reversionary interest fell in, the respondent or his predecessors as trustees of the Cosier estate. In support of his argument the respondent relied principally on the decision in Inland Revenue Commissioners v. Lawrence, Graham & Co. [F45] That case like the present dealt with the liability of trustees of a reversionary interest to pay income tax on the sum available for payment of interest which had passed through their hands on its way to the mortgagee when the reversionary interest fell in. Two points were decided. It was held
- (1.)
- that the capitalization of interest from time to time did not constitute a payment or payments of the interest by the notional making of a further loan from the mortgagee to the mortgagor which was then added to the capital sum due.
- The case of Inland Revenue Commissioners v. Holder [F46] (affirmed in your Lordships' House on another ground: Holder v. Inland Revenue Commissioners [F47] was distinguished on the ground that principles applicable to the capitalization of interest by bankers did not apply to interest due on a mortgage debt; but
- (2.)
- that the agreement for capitalization followed by capitalization, either because the mortgage deed provided for that result following or because an option was given by it to capitalize by the mortgagor, did amount to payment, since there was an agreement to substitute this capital charge for payment in cash.
It was held, however, that the obligation was only to pay a net sum, viz. the gross sum due less tax; the net sum therefore and not the gross sum should be added to the capital and the borrower must be taken to have deducted on each occasion the amount due for tax. The judgment goes on: [F48]
"This being so, when the respondents paid to the society out of the purchase money the sums that had been so added to the principal moneys secured, they were paying a sum that had already suffered tax and were under no liability to make any further deduction."
So it was said here the respondent in handing over so much of the capital sum in his hand as was applicable for the payment of interest was handing over a sum from which tax had already been deducted; he had received and was paying only a tax-free sum and although the rest of the estate of the late Mrs. Beyfus (if there had been any) would have been liable for the tax so notionally deducted, the respondent was not.
My Lords, the representatives of the Crown sought to distinguish that case from this on the ground that the mortgage agreement in the Lawrence, Graham & Co.'s case [F49] stipulated for net interest only, whereas the present case stipulated for gross interest. Whether the mortgage deed in the former decision did require a payment of net interest only may perhaps be doubted, but whether it did so or not cannot, I think, affect the principles to be applied. If then the decision in that case be right the decision of the Court of Appeal in this case was right also. The Commissioners accordingly argued that if no valid distinction could be made, the case of Lawrence, Graham & Co. [F49] should be overruled.
My Lords, I cannot think that the provision contained in the mortgage deed now in question, whereby an option was given to the mortgagee to capitalize interest unpaid for twenty-one days after it became due, amounted to payment. As my noble and learned friend Lord Russell of Killowen, then Russell J., when dealing with the question of capitalized interest said in In re Jauncey: [F50]
"In the case of such a provision as is contained in the present deed, which enables the interest to be capitalized, the interest is not capitalized because it is in fact paid but because it has in fact not been paid."
To the same effect Lord Sterndale M.R. in In re Morris, speaking of capitalization in a case where capitalization was not expressly provided for, said:
"I think that the word 'capitalization' used in many of the books quoted is a convenient word, but for the purposes for which it has been used in the argument before us it is a fallacious word, because it is taken as referring to capitalization for all purposes, income tax and otherwise. I do not think that is the meaning of the word. In my opinion - not to beg the question - when these sums of interest come to be paid at the end of the time when payment is made, although interest has been charged upon them, and although, as a matter of bookkeeping, they have from time to time been added to capital, they do not cease to be interest of money - that is to say, they are overdue interest upon which interest has been paid."
Had the sum in question in the present case been bank interest on a loan the question whether the interest there had been paid by adding it to the capital sum borrowed would have been determined by your Lordships' decision in Paton v. Inland Revenue Commissioners. [F52] At an earlier date, in Inland Revenue Commissioners v. Holder, [F53] the Court of Appeal had decided that the capitalization of bank interest ought properly to be regarded as a fresh borrowing of interest by the borrower from the bank followed by the application of the sum so notionally borrowed in payment of the interest due, with the result that there was a payment at the moment of capitalization.
In Paton's case your Lordships held that this was not so and that the debiting of interest in the account did not constitute, as between the borrower and the bank, a payment of interest under s. 36, sub-s. 1, of the Income Tax Act, 1918. My Lords, I do not find myself able to distinguish in principle between that case and the one the House is now considering. In each case there is a debt and in each case there is a contract under which, in default of payment, a so-called capitalization of interest takes place. It is true that in the one case the contract is constituted by the custom of bankers and in the other by a deed of mortgage, but the substance, though not the machinery, is the same. Capitalization means no more than that interest, which continues to be interest, shall be treated together with the capital sum due as itself interest-bearing but does not alter its quality as interest.
There being then no payment until the funds were handed over in pursuance of the agreement of July 20, 1939, there could be no earlier deduction and up to that time no deduction of tax had in fact taken place. The respondent was therefore under an obligation to deduct from the sum paid to the mortgagee's trustees and account to the revenue for the tax then due unless for some other reason he was excused. It was sought to find such an excuse by a contention that he had not handed over money and could not deduct money from an obligation which he had met by handing over a commodity. This argument, as to the merits of which I say nothing, fails in my view in limine. I think the Attorney-General was right when he said that under the agreement of June, 1939, the parties were not seeking to avoid payment in sterling - they were merely seeking to arrange a satisfactory position in which the respondent should retain part of the sum due in order to answer his liability (if any) to account for income tax.
I would allow the appeal.