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

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(Decision by: Lord Normand)

Between: Smith's Potato Estates Ltd
And: Bolland (Inspector of Taxes)
Between: Smith's Potato Crisps (1929) Ltd
And: Inland Revenue Commissioners

Court:

Judges: Viscount Simon
Lord Porter
Lord Simonds

Lord NormandLord 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

Hearing date: 19, 20, 22, 23 APRIL 1948
Judgment date: 14 JULY 1948

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Decision by:
Lord Normand

My Lords, the questions in these appeals are whether the costs and expenses of a successful excess profits tax appeal are a proper deduction in computing profits and gains either for the purposes of income tax or for the purposes of excess profits tax, but these questions can in effect be reduced to the single question whether the costs and expenses are deductible in computing the profits for the purposes of income tax, and it can also be said that it would have made no difference if the costs had been incurred in prosecuting an income tax appeal. Profits for excess profits tax purposes are computed on income tax principles, and, though excess profits tax is, under s 18 of the Finance (No 2) Act, 1939, allowed to be deducted in computing profits for the purposes of income tax, this express allowance, which does not extend to the costs and expenses of appeals, is, in my opinion, directed to limiting the total taxation of trade profits and distributing it between the two taxes in accordance with the intention of Parliament. Apart from the provisions of s 18 of the Finance (No 2) Act of 1939, excess profits tax would not be deductible any more than income tax itself is deductible in computing profits for income tax purposes. The reason why income tax is not deductible in computing profits for income tax purposes is not merely the logical difficulty pointed out by counsel for the appellants that, if it were, the computation would inevitably drift through the repetition of the deduction into the eddy of an indefinite process. There is the more substantial reason that income tax is an impost made on profits after they have been earned, and that, unless the observations of Lord Davey in Strong & Co Ltd v Woodifield ([1906] AC 448, 453), which have often been referred to and applied in later cases, are to be disregarded, a payment out of profits after they have been earned is not within the purposes of the trade carried on by the taxpayer. But excess profits tax also is levied on profits after they are earned, and, apart from the statutory provision, is in pari casu with income tax.

The issue is, accordingly, whether the costs and expenses of an income tax or an excess profits tax appeal would properly be entered on the debit side of an account of disbursements and receipts framed for the purpose of arriving at the full amount of the profits and gains of a company's trade under Case I of sched D, or whether r 3(a) of the Rules Applicable to Cases I and II of Sched D prohibits their deduction as not being money wholly and exclusively laid out or expended for the purposes of the company's trade. Every trading company must keep books of account, and these books are used by the accountants for the purpose of making up the commercial profit and loss account. The accountants may use that account by applying to it the modifications which income tax law requires in order to bring out the profit for income tax purposes, and they may have to negotiate with Inland Revenue officials in order to justify their account of profits, and, perhaps, to obtain a correction of an assessment. It will also be necessary to prepare an account showing the amount of the distributable profits after making provision for the income tax liability. As the first and the last of these accounts are among the purposes of the trade, he taxpayer may say that the whole accounting process, including even the prosecution of an appeal in order to determine the correct income tax assessment, is carried out for the purposes of the trade, and it may be added that the proper conduct of the trade requires that the assessment shall be correct. On the other hand, it may be said that there is in strictness no part of the accounting process which is not directly or indirectly concerned with income tax liability and that, as the payment of income tax is not a purpose of the trade, none of the costs incident to the accounting process is laid out exclusively for the purposes of the trade. That would be an extreme and, I think, an untenable proposition. The Inland Revenue's contention in these appeals did not go nearly so far. It was that the costs and expenses of appeal proceedings before the Commissioners of Inland Revenue or the Board of Referees and from them to the courts are not laid out exclusively for the purposes of the trade, and are, therefore, not permissible deductions. The line drawn by the Inland Revenue would allow deduction of the costs incurred in negotiations with their officers before an appeal is taken, or where no appeal is taken, either as a concession to the taxpayer or as a practical and convenient settlement of a disputable point. The costs of an appeal against an assessment are incurred at least in part, if not exclusively, for the purposes of reducing the payment which the taxpayer will have to make if he acquiesces in the assessment. The purpose of the appeal is not limited to correcting the assessment itself, for if the assessment involved no liability to pay no one would go to the trouble and expense of appealing against it. So, even if the correction of the assessment is within the purposes of the trade, the expenses and costs of the appeal are nevertheless laid out at least partly for a purpose which is not one of the purposes of the trade. They are accessory to the payment of a tax out of profits and are non-deductible because the tax itself is non-deductible.

As I understand the judgment of the learned Master of the Rolls in the Rushden Heel case that is the ground on which he has decided the general question against the appellants. I refer specifically to the following passage, which I would respectfully adopt ([1947] 1 All ER 699, 702):

I am prepared to assume (although I do not so decide) that the ascertainment of the proper amount of tax payable ought, as the taxpayers argue, to be regarded as necessary for the proper carrying on of the trade and, therefore, for earning profits in the future, but I cannot agree that the money can be said to have been laid out "wholly and exclusively" for that purpose. It was laid out, as it appears to me, just as much, if not more, for the purpose of ensuring that the company, like any other taxpayer, should pay the proper amount of tax, no more and no less.

I agree also with the further observation that an accountancy expense incurred solely for the purpose of conducting a tax controversy with the Crown cannot be deducted. In these appeals a subsidiary or alternative argument was presented that the real purpose of the excess profits tax appeal was to retain the services of a valuable employee, but the findings of fact do not go so far as this. They mean only that the directors had that in view as one of the objects of the appeal. Even if it was a principal object it would, nevertheless, not exclude the payment of the correct amount of tax as another important purpose of the appeal. I would refuse the appeals.