Case E48

Judges:
AM Donovan Ch
GR Thompson M
RK Todd M

Court:
No. 2 Board of Review

Judgment date: 1 November 1973.

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A.M. Donovan (Chairman); G.R. Thompson and R.K. Todd (Members): In October 1968, as a step in the arrangement of her affairs for the purpose of minimising probate duty, Mrs. A, then about 66 years of age, entered into a contract with the taxpayer company, the shareholders of which are her two children and their spouses. The contract provided that, in consideration of the sum of $200,000 paid by Mrs. A to the taxpayer company, it would pay her during her lifetime an annuity of $18,200 by quarterly instalments. The annuity was expressed to be calculated in accordance with the rates applicable to a person of Mrs. A's age published as Table K by a large life assurance company.

2. During the year ended 30 June 1969, the taxpayer company, which has never entered into any similar agreement, received the amount of $200,000 and used that sum either to purchase income-producing assets or to repay amounts previously borrowed and used for that purpose. It made the first two quarterly annuity payments during that year, and in its relevant return of income it claimed a deduction of $2,112 under the description ``Annuity-income apportionment''. The disallowance of this claim gives rise to the present reference.

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3. To explain how the amount of $2,112 was calculated, it is necessary to refer to the position of Mrs. A. Her payment of $200,000 as the purchase price of the annuity represented a capital outgoing which on general principle was not deductible for income tax purposes. On the other hand, each payment of annuity received constituted assessable income pursuant to the provisions of sec.26AA of the Act. To avoid the hardship which would otherwise result from the conversion of capital into income, that section provides for the exclusion from assessment in the case of a purchased annuity of ``that part... which represents the undeducted purchase price''. It sets out how the undeducted purchase price is to be calculated, and in the particular circumstances of this case it was the cost price of $200,000 divided by 14.31, being the expectation of Mrs. A's life according to the life tables prescribed for the purpose of the section. From the two quarterly annuity payments of the year ended 30 June 1969, the amount excluded was $6,983, leaving an assessable amount of $2,112. The deduction claimed by the taxpayer company coincides with this amount and was calculated in the same way.

4. In essential features, the facts of the present reference are similar to those considered by the High Court in
The Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1953) 89 C.L.R. 428. There it was held that a payment equivalent to 90% of rent received by the Society from specified property contracted to be paid for a period of 50 years in consideration of the transfer to the Society of a capital asset was not deductible to it under sec.51 of the Act. It was on this authority that the Commissioner's representative substantially relied to support the disallowance of the present claim.

5. In the course of his very closely reasoned submissions, counsel for the taxpayer company recognised the difficulty presented by this decision, but he said that it only applied if a deduction was sought for the whole amount of the annuity paid and left quite untouched the question whether a part only of the payment was deductible. On this aspect he submitted that, of its very nature, interest is a deductible outgoing if it has the nexus with the production of income required by sec.51. He then relied on decisions in
Vestey v. I.R. Commrs. 1962 Ch. 861, and
Secretary of State in Council of India v. Scoble 1903 A.C. 299, as providing the necessary authority to examine the annuity payments to determine whether they include ``an ascertainable interest component''. He submitted that the annuity payments under consideration did include such a component. Whether they did so is the only question to which we propose to direct attention.

6. In part the evidence upon which reliance was placed in this regard was given by the accountant who took part in the discussions leading to the contract in question. In answer to the question: ``Bearing in mind the interest component (of the annuity), was consideration given to the question whether it would be calculated in accordance with sec.26AA'', he replied: ``Yes''. Counsel interpreted this reply as meaning that both parties had assumed in their discussions ``that the interest component was a component to be worked out under the sec.26AA method''. But that section merely operates to exclude what is referred to as the undeducted purchase price of an annuity, and neither expressly nor inferentially confers on the assessable balance of the annuity the character of interest.

7. An actuary who also gave evidence said that if it were assumed that Mrs. A's life span would coincide precisely with the expectation under the prescribed life tables, she would receive by way of annuity $200,000 and in addition an amount equivalent to an interest rate of 3.82% per annum. He also said that on one basis of calculation the ``interest'' in the first two payments of annuity exceeded the amount of deduction claimed by the taxpayer company. Nothing in his evidence, however, did anything to establish that any part of the amount paid as annuity was in fact interest.

8. A copy of Table K, by reference to which the annuity in question was calculated, was not put in evidence. It seems, however, to have set out the cost price of whole-of-life annuity for persons of various ages. It can be

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assumed that the cost price in any particular instance would be something less than what a purchaser would get back if his life span coincided exactly with that determined from the life tables prescribed for the purposes of sec.26AA. In that event, the life assurance company would make a profit only if the difference between the two figures was less than what it could earn on the purchase consideration in its hands. Of course, profits or losses would arise if an annuitant lived a shorter or longer time than that indicated by the life tables, but provided a sufficiently large number of annuities were granted the dates of cessation of all annuities should approach the average determined from the life tables and profits and losses on that account should counterbalance. Thus, it might well be possible for a life assurance company to predict with confidence that it would make neither a profit nor a loss because of the date of cessation of annuities in general, although obviously it could not do so in relation to any particular annuity.

9. If these assumptions are correct, life assurance offices could be expected to pay particular regard to the earning rate of the funds in their hands and, as a matter of internal accounting, to determine whether any particular payment of annuity was made wholly or in part from purchase money or from income derived thereon. This coincides with the actuary's evidence, for in reply to a question as to what he meant by the interest component of an annuity, he said: ``If you are in the position of a company which is paying an annuity to somebody, you will have been paid a lump sum in the first place which you invested. This will earn interest, so you have in this case each quarter a certain amount of interest which you give to the annuitant, but to some extent you will have to realise your capital and pay some of the annuity out of capital.'' The actuary's evidence thus showed that an annuity may be paid out of an income fund but it did nothing to characterise the essential nature of the annuity payment itself or of any part of it.

10. Interest has been described as ``the return or compensation for the use by one person of a sum of money belonging to or owed to another'', Halsbury, 3rd Edition, Vol.27, p. 7. It is in this sense that the word is ordinarily used, and it was in this sense, as we understood it, that counsel used it in his submissions. Tested in the light of this definition there was no component of interest in either of the payments here under consideration. The amount of $200,000 paid by Mrs. A to the taxpayer company became its absolute property. On the other hand, she became entitled to annuity payments when, and only when, she survived the due dates of payments. Prior to those dates the taxpayer company had no obligation to make any payment whatever. The contract in question was not one which in any sense partook of the nature of a loan nor was it one where something is purchased for a price to which some amount is added because it is paid by instalments. It was a contract where Mrs. A parted with a sum of money in return for the right to receive payments throughout her lifetime, that is to say a period which at the time could not be determined. It is perfectly true that when the annuity finally ceases a calculation can be made of the amount received by Mrs. A. If it exceeds the amount of $200,000 paid by her, the excess can be expressed as equivalent to interest at a calculated rate per centum per annum, but the ability to make such a calculation does not confer on that excess the character of interest.

11. In the light of what has been said, the submissions that the annuity payments contained ``an ascertainable interest component'' must be rejected. This is so because there was no evidence to that effect and no material upon which an inference to that effect could be drawn. Indeed, it was only by making the assumption which is completely unwarranted that the annuitant's life would coincide with her expectation of life according to the life tables that the deduction claimed could be quantified.

12. In the circumstances, we find it unnecessary to consider in any detail the authorities to which counsel referred us. In Vestey v. I.R.Commrs. (1962) Ch. 861, the facts were that shares were transferred for a price of £5,500,000 payable without interest by 125 yearly instalments. The Crown sought to assess the instalment in its entirety as an annuity, while the taxpayer contended that it represented an instalment of the sale price of

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a capital asset and was therefore totally exempt from tax. Cross J. decided that the value of the shares at the time of the contract was £2,000,000 and that the balance represented interest, and that to the extent to which each instalment contained an interest component it was assessable. Substantially the same approach was adopted by Cross J. in the later case of
I.R.Commrs. v. Land Securities Investment Trust Ltd. (1968) 1 All E.R. 955, where he concluded that rent charges given for a period of 10 years in consideration of the transfer of capital assets contained an ascertainable component of interest which was deductible. On appeal the House of Lords rejected his view ((1969) 2 All E.R.430). At p.434, Lord Donovan, in the course of his speech, said -

``Cross, J. in the Chancery Division thought that the rent charges could, for the purposes of tax only, be dissected into capital and interest components and the latter alone allowed as a deduction. In this respect he considered that the present case was similar to Secretary of State in Council of India v. Scoble, and Vestey v. I.R.Commrs. Like the Court of Appeal, I do not think that these cases are really in point. In the former a capital sum had been agreed as the purchase price, and the inference could be drawn that the so-called annuity was the payment of this sum by instalments together with interest. Cross, J. was able to draw a like inference in the latter case. But in the present, it is common ground that no such capital sum was agreed before hand; and, furthermore, counsel for the Crown said... that he disclaimed any right to go behind the contract and show that the payments were not rent charges.''

The decision of the House of Lords in allowing this appeal is consistent with that of our own High Court in Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (supra) some 16 years earlier.

13. As in the Land Security case, the taxpayer in this reference had not agreed before hand to pay a capital sum which was incorporated in the annuity payments. The reasons for decision therefore afford strong support for the disallowance of the present claim.

14. Counsel very properly directed the Board's attention to an aspect of the Land Security case to which we have not yet adverted. It is sufficiently explained in a further passage of Lord Donovan's speech at p.434 -

``Nevertheless on the basis (apparently) that some element of interest had been used to calculate the amount of the rentcharges, he (counsel for the Crown) said that interest being an allowable deduction for profits tax purposes, the Crown were prepared to allow as an expense what, for want of a better term, I might call the `interest content' of the rentcharges on the basis aforesaid. I cannot say that I understand how this offer squares with the Crown's main contention, and its admissions, but since it was made and accepted by counsel for the taxpayer company, I leave the matter there without further comment. I would therefore allow the appeal, and remit the matter to the Special Commissioners to restore the assessments, but adjusting them in the manner offered by the Crown. The rate of interest to be employed for this purpose should be 5.6045 per cent, per annum, a rate which your Lordships have now been informed has been agreed between the parties.''

With great respect we have the same difficulty in understanding the Crown's concession to which reference was made, but in any event the practice of the Revenue Authorities in Britain has no relevance for the purposes of this reference. Counsel of course did not for one moment suggest otherwise but only pointed to the practice to show that the present claim was of a type recognised elsewhere. But even if the dissection of the rent charges into interest components was properly undertaken in that case, no assistance is thereby afforded to the taxpayer in this reference. This is so because the rent charges there under consideration

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ran for a stipulated time, while here the annuity payments continue for the indeterminate period of the annuitant's life. Quantification of an interest component, even if otherwise permissible and possible, must involve a factor of a definite time.

15. We uphold the Commissioner's decision on the objection.

Claim disallowed