Smith's Potato Estates Ltd v. Bolland (Inspector of Taxes); Smith's Potato Crisps (1929) Ltd v Inland Revenue Commissioners
[1948] 2 All ER 367[1948] AC 508
(Decision by: Lord Porter)
Between: Smith's Potato Estates Ltd
And: Bolland (Inspector of Taxes)
Between: Smith's Potato Crisps (1929) Ltd
And: Inland Revenue Commissioners
Judges:
Viscount Simon
Lord PorterLord Simonds
Lord Normand
Lord Oaksey
Subject References:
Excess Profits Tax
Deductions
Cost of litigation
Appeal vital to retain services of valuable employee
Income Tax
Deductions
Cost of Litigation
Appeal vital to retain services of valuable employee
Legislative References:
Income Tax Act 1918 (c 40) - sched D, Rules Applicable to Cases I and II, r 3 (a)
Finance Act 1940 (c 29) - s 32(1)
Finance (No 2) Act 1939 (c 109) - s 14(1)
Case References:
Allen v Farquharson Bros & Co, considered - (1932) (17 Tax Cas 59)
Worsley Brewery Co Ltd v Inland Revenue Comrs, considered - (1932) (17 Tax Cas 349)
Strong & Co Ltd v Woodified - [1906] AC 448; 75 LJKB 864; 95 LT 241; 5 Tax Cas 215; 28 Digest 57, 290
Smith v Lion Brewery Co Ltd - [1911] AC 150; 80 LJKB 566; 104 LT 321; 5 Tax Cas 568; 75 JPJo 87; 28 Digest 57, 291
Usher's Wiltshire Brewery Ltd v Bruce - [1915] AC 433; 84 LJKB 417; 112 LT 651; 6 Tax Cas 399; 28 Digest 56, 286
British Insulated & Helsby Cables v Atherton - [1926] AC 205; 95 LJKB 336; 134 LT 289; 28 Digest 52, 264
Allen v Farquharson Bros & Co - (1932) 17 Tax Cas 59, Digest Supp
Mersey Docks & Harbour Board v Lucas - (1883) 8 App Cas 891; 53 LJQB 4; 49 LT 781; 48 JP 212; 2 Tax Cas 25; 28 Digest 21, 104
Rushden Heel Co Ltd v Keene (Inspector of Taxes), Rushden Heel Co Ltd v Inland Revenue Comrs - [1947] 1 All ER 699
Worsley Brewery Co Ltd v Inland Revenue Comrs - (1932), 17 Tax Cas 349
Judgment date: 14 JULY 1948
Decision by:
Lord Porter
My Lords, these consolidated appeals raise this question whether in computing their profits for income tax purposes in respect of the year ending 31 March 1934, the appellants in the first appeal are entitled to deduct a sum of £622 10s 11d, being the legal and accountancy expenses incurred in prosecuting an appeal to the Board of Referees against a decision of the Commissioners of Inland Revenue, given under s 32 of the Finance Act, 1940. These appellants are a wholly owned subsidiary of the appellants in this second appeal and the matter for decision in that case is whether the same sum is deductible in computing the profits of the first appellants for the purpose of assessment to excess profits tax for the chargeable accounting period ending on the same date. Under the provisions of para 2 of pt I of sched V to the Finance Act, 1940, assessments to excess profits tax in respect of the profits of the first appellants fall to be made on the second appellants, but with a provision under para 8 of pt IV of that schedule for the reimbursement by the first appellants of the second appellants if they pay the tax.
The first appellants were formed to purchase and manage an estate at Nocton in Lincolnshire on which it was hoped to grow a supply of potatoes sufficient for the requirements of the second appellants. That estate, before its purchase, had been managed by a Mr Young and in order to ensure its successful working it was thought essential to continue to employ him for that purpose. After four years' service Mr Young was dissatisfied with the terms of his remuneration, and on 4 March 1941, a new agreement was entered into between him and the first appellants for a term of six years certain from 6 April 1940, and thereafter until determined by six month's notice on either side. Under this agreement he received an increased remuneration amounting in 1940 to £3,550, in 1941 to £6,486, in 1942 to £6,198, in 1943 to £5,334, in 1944 to £5,747 and in 1945 to £2,416. On 15 August 1942, the Commissioners of Inland Revenue issued to the secretary of the first appellants a notice stating that under s 32 of the Finance Act, 1940, they had decided that, in computing, for the purposes of excess profits tax, the profits of that company's trade or business for the accounting period ending 31 March 1941, no deduction should be allowed in respect of Mr Young's remuneration in excess of £3,500. From this decision both companies appealed to the Board of Referees and that body held that £5,800 was allowable. From and after that period the Inland Revenue authorities have not challenged the allowance of the full amount actually paid and the sum now in dispute represents the costs incurred in prosecuting this appeal.
Under sched D tax is charged in respect of the annual profits or gains arising or accruing to any person residing in the United Kingdom and the relevant statutory provisions as to the deductions to be allowed are to be found in r 3(a) of the Rules Applicable to Cases I and II of sched D and read as follows:
- (3)
- In computing the amount of profits of gains to be charged, no sum shall be deducted in respect of -
- (a)
- any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, profession, employment, or vocation ...
Excess profits tax is dealt with in s 14(1) of the Finance (No 2) Act 1939, which enacts that for the purposes of that tax the profits arising from a trade or business should be computed on income tax principles, as adapted in accordance with the provisions of pt I of sched VII to the Act, and defines income tax principles in relation to a trade or business as the principles on which the profits arising from the trade or business are computed for the purpose of income tax under Case I of sched D or would be so computed if income tax were chargeable under that Case in respect of the profits so arising. The only other provision of this Act which need be quoted is that contained in s 18(1), viz:
The amount of excess profits tax payable in respect of a trade or business for any chargeable accounting period shall, in computing for the purposes of income tax the profits and gains arising from that trade or business, be allowed to be deducted as an expense incurred in that period ...
The appellants relied on this last section, coupled with the fact that excess profits tax is imposed on traders only, and urged that the expenses of ascertaining the sum properly deductible as excess profits tax from income tax was an expense wholly and exclusively laid out for the purposes of the trade. A subsidiary question arises whether the expenditure incurred in order to ascertain the sum properly allowable was undertaken to save tax or for the purposes of retaining the services of Mr Young, but from the facts already stated it is plain that the main question in the case is concerned with the true meaning of the expression "wholly and exclusively laid out or expended for the purposes of the trade," and, more particularly with the phrase "purposes of the trade."
The phraseology and its meaning have been dealt with in a considerable number of cases, but before considering their effect I think it desirable to state the conclusion at which I should have arrived from a study of the wording of the section itself. The widest meaning attributed to it, and that for which the appellants contend, is, perhaps, best expressed by saying that it includes every expense to which the trader is put because he carries on the trade. Were he not a trader, it is contended, he would not have to pay excess profits tax, and, therefore, any expense to which he is put in arriving at its correct figure is wholly and exclusively laid out for the purposes of the trade. Similarly, it is maintained that, as the law obliges him to pay income tax, his expenses of calculating the balance of profits and gains for income tax purposes are incurred wholly and exclusively for the purposes of his trade, more particularly where the taxpayer is a company which by law is compelled to publish its accounts. In support of this argument it is urged that even the amount available to be put aside as reserve or for distribution in dividends cannot be ascertained until it is known what sum must be provided for excess profits and income tax purposes. The argument, so far, extends only to expenditure incurred for the purpose of finding out what the balance of profits or gains is, but, it is said, if the cost of ascertaining that balance by making up the company's accounts is wholly and exclusively laid out for the purposes of its trade, so the expense of ensuring by an appeal to the Board of Referees the correctness of the figure reached is equally wholly and exclusively laid out for those purposes. The opposite view maintained by the Crown is, perhaps, best expressed in Strong & Co Ltd v Woodifield ([1906] AC 448, 453), where Lord Davey says:
"These words ... appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade ..."
My Lords, that expression has often been referred to and approved, but it was used in reference to the circumstances of the case then under consideration, and I doubt if it carries the matter to a final conclusion. It still leaves open the question what expense is incurred for the purpose of enabling a trader to earn profits, and the adoption of a phrase helpful in analysing the meaning of words in an Act of Parliament with reference to a particular set of circumstances is not necessarily either useful or conclusive in all cases. It is probably safer to retain the wording of the Act itself, and, by applying it to the facts established, to discover whether the deduction falls within its terms or not.
Regarding the circumstances which your Lordships have to consider from this point of view, I should myself draw a marked distinction between accounts made up on the purely trading basis and those which are prepared for and accepted by the Inland Revenue. If there were no obligation to ascertain and pay either of these taxes, there would be no necessity for making up accounts on income tax principles-it would suffice to make up the ordinary commercial accounts. The computation of accounts for tax purposes is, therefore, not directly associated with the carrying on of the business. It is an obligation imposed on the company for another and extraneous purpose, ie, for the purpose of ascertaining the tax to be paid out of profits. It is not, at any rate directly, undertaken for trade purposes, but to satisfy the revenue authorities.
It is true that as a matter of convenience, the cost of making up accounts for the Inland Revenue is allowed by the authorities as a deduction from profits as is the cost of making up the strictly business accounts of the trade, but this is a matter, not of principle, but of expediency. The two duties overlap and in practice are almost indivisible. Moreover, it is of advantage to the Revenue to have the figures required for their purposes carefully and accurately made up. Strictly, however, I think the expenses should be divided and any additional cost of making up Revenue accounts should be disallowed in determining the allowable deduction for income tax purposes, but the advantages of allowing both to be deducted as a practical measure outweigh the disadvantages though the result may not be strictly logical. But no such illogicality has to be faced when the sum which is alleged to be deductible is not the cost of accountants' work in ascertaining trading profits, but the expense of an appeal to the Board of Referees for the purpose of discovering the true measure of profits for tax purposes only. Such expenditure is incurred directly for tax purposes and for nothing else, though it may indirectly affect both the amount available for distribution to the proprietors of the business and that proper to be put to reserve.
This is the conclusion which I should have reached if left to determine the question unassisted and unembarrassed by authority. It remains to be determined whether your Lordships' decision in previous cases throw doubt upon this view. My Lords, Strong & Co Ltd v Woodifield may be said to form the starting point for deducing the principles at stake in the present appeal, and, though the words of Lord Davey quoted above are the expression most frequently referred to, I think that those of Lord Loreburn LC have equal, if not greater, importance. He says ([1906] AC 448, 452):
... it does not follow that if a loss is in any sense connected with the trade, it must always be allowed as a deduction; for it may be only remotely connected with the trade or it may be connected with something else quite as much as or even more than with the trade. I think only such losses can be deducted as are connected with in the sense that they are really incidental to the trade itself. They cannot be deducted if they are mainly incidental to some other vocation or fall on the trader in some character other than that of trader.
Further, Lord Davey, after pointing out that Case I relates to trades, manufactures, adventures or concerns in the nature of trade, goes on to say (ibid, 453):
It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade, or is made out of the profits of the trade. It must be made for the purpose of earning the profits.
These expressions of opinion, given some forty years ago, and accepted ever since are, in my view, inconsistent with the appellants' contention, but it is said they are at best dicta and are inconsistent with the principles on which such authorities as Smith v Lion Brewery and Usher's Wiltshire Brewery v Bruce are based and, in particular, with the observations of Viscount Cave LC in British Insulated & Helsby Cables Ltd v Atherton ([1926] AC 205, 211, 212), who says that it has often been pointed out that the Act does not contain any express allowance or enumeration of deductions, and, therefore, it is necessary first to inquire whether the deduction is expressly prohibited, and, if not, whether it is of such a nature as to be proper to be charged against incomings in a computation of the balance of profits and gains. He goes on to state that:
... a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade ...
My Lords, this statement was obiter only as the actual decision was merely that the expenditure was capital expenditure, and, therefore, not deductible, but the language does require careful consideration. In that case the question actually in issue was whether subscriptions by a company towards a pension fund were to be deducted in ascertaining the balance of profits and gains of its trade. It was true that the expenditure did not at once affect its revenue, but it was a method of ensuring the better and more contented service of its employees and in that sense it did directly affect the success of its enterprise. It was exclusively laid out to enable the company to be more successful: no part of it was incurred in order to ascertain the Revenue's proportion of the profits when made. So far as income tax is concerned there is direct authority in the High Court in Allen v Farquharson that the cost of opposing the Inland Revenue in a contest as to what the profits of a business are is not deductible, but, it is said, that case merely followed Strong & Co Ltd v Woodifield, and, in any case, excess profits tax differs in as much as it is imposed on a trader only, and, therefore, the cost of ascertaining it is part of the trade. I do not accept this contention. It is true that a trader only is liable to pay it, but it is not payable by him as a trader. He pays as an individual, like any other individual, the tax on the sum which he has earned as a trader. "To my mind," said Lord Selborne LC, in Mersey Docks & Harbour Board v Lucas ([1883] 8 App Cas 891, 905), "it is reasonably plain that the gains of a trade are that which is gained by the trading, for whatever purposes it is used ... ", and, therefore, what your Lordships have to determine is whether the expense is incurred in order to earn gain or is the application or distribution of that gain when earned. With all respect to the opposing view, expenditure to ascertain the true amount of tax to be paid, whether it be income tax or excess profits tax and whether successful or unsuccessful, is, in my opinion, incurred, at any rate in part, in order to determine the correct amount of income tax or excess profits tax as the case may be and not in order to earn gain even though that phrase be given a broad significance. The same conclusion might be reached by saying in the words of this statute that such expense is not wholly or exclusively laid out for the purposes of trade. It is, in truth, partially, if not wholly, laid out in order to discover what sum is to be paid to the Crown out of the profits or gains which have already been earned and computed.
In these two consolidated appeals the further point was argued that those appeals were launched and consequent expense incurred in order that Mr Young's services might be retained. The Special Commissioners, however, have found that one main object, though possibly not the most prominent, was to save tax. They had evidence on which they could so find and in these circumstances, this is not a matter in which your Lordships would interfere. I should dismiss both appeals.