Ostime (Inspector of Taxes) v Australian Mutual Provident Society

[1960] A.C. 459

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(Judgment by: Lord Denning)

Between: Ostime (Inspector of Taxes) - Appellant
And: Australian Mutual Provident Society - Respondent

Court:

Judges: Lord Radcliffe
Lord Tucker
Lord Somervell of Harrow

Lord DenningLord Birkett

Subject References:
REVENUE
INCOME TAX
DOUBLE TAXATION RELIEF
Life assurance
Mutual life assurance association in Australia
Branch office in United Kingdom
Assessments to income tax on life fund interest
Competence of assessments
'Industrial or commercial profits'
Whether taxable surpluses properly so described

Legislative References:
Income Tax Act, 1918 (8 & 9 Geo. 5, c. 40) - Sch. I, Sch. D, Rules applicable to Case III, r. 3
Income Tax Act, 1952 (15 & 16 Geo. 6 & 1 Eliz. 2, c. 10) - s. 430
Double Taxation Relief (Taxes on Income) (Australia) Order, 1947 (S.R. & O., 1947, No. 806) - Sch., art. II (1) (i), (3); art. III (2), (3)

Hearing date: 4, 8-9 June 1959
Judgment date: 16 July 1959

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Judgment by:
Lord Denning

My Lords, your Lordships have to consider today the effect of certain arrangements about taxation which have been made between the governments of the United Kingdom and of Australia. These arrangements have been made so as to ensure that persons are not taxed twice over, once by the United Kingdom and once by Australia, on the same income. They have been embodied in an agreement (which I will call the Double Taxation Agreement) and given statutory force in each country. They override any other enactment. Similar agreements in like terms have been made by this country with other countries and by other countries between themselves. The interpretation which your Lordships put upon this Double Taxation Agreement is of more than usual consequence because, if a mistake should be made, it may be well nigh impossible to put it right, for your Lordships' interpretation will govern this country without any likelihood of change by Parliament. At any rate Parliament itself cannot alter the wording of this Double Taxation Agreement, without the consent of both parties to it.

The important thing to notice about the Double Taxation Agreement is that in defining "industrial or commercial profits" it draws a sharp distinction between profits from a business on the one hand (which I will call "business profits") and income in the form of dividends, interest, rents and so forth on the other hand (which I will call "investment income"). It deals with these quite separately. So far as "business profits" are concerned, the Double Taxation Agreement says that henceforward when an Australian company has a permanent establishment in this country, it may be taxed by the United Kingdom on the profits it makes, but only on so much of them as is attributable to its establishment here. The agreement goes on to say how this amount is to be ascertained. It is by means of a given hypothesis. You are to treat the establishment here as if it were completely independent of the Australian head office and were dealing at arm's length with it, and you are to estimate the profits which such an independent enterprise might be expected to derive on its own, and then tax it on the amount so ascertained.

So far as "investment income" is concerned, the tax payable in this country is left untouched by the Double Taxation Agreement. For instance, where an Australian company has investments in this country from which it derives dividends, interest, rents and so forth, it has, of course, to pay tax on that income here by deduction or otherwise. But over in Australia the Australian company, inasmuch as it is an Australian resident, will have to pay Australian tax on all its investment income, wherever derived, including its income from investments in the United Kingdom. The Double Taxation Agreement provides that, when paying this Australian tax in Australia, the Australian company will receive credit for the tax it has paid in the United Kingdom.

Such being the general effect of the Double Taxation Agreement, your Lordships are today concerned with its effect on a very special kind of tax which is imposed here under rule 3 of Case III. It is a tax charged on life assurance companies which have their head office overseas and a branch or agency in the United Kingdom. The critical question is whether it is a tax on profits of the business so as to come within the provisions of the Double Taxation Agreement about "business" profits or whether it is rather a tax on investment income so as to come within the relevant provisions about "investment income."

My Lords, in order to explain the nature of this special tax I would first say a little about the business of life insurance itself. First, take a mutual society. It carries on business on a mutual basis, and it is settled law that it makes no trading profits but only a surplus and is not liable to tax upon that surplus: see New York Life Insurance Co. v. Styles and Inland Revenue Commissioners v. Ayrshire Employers' Mutual Insurance Association Ltd. But it is, of course, liable to tax on its investment income. Secondly, take a proprietary society. It carries on business on a proprietary basis and may in theory make a trading profit, but there is much difficulty in calculating it. It is difficult to say what profit there is when you receive premiums and may have to pay out big sums at some unknown future time. In any case the actuaries seek to calculate the premiums so that they just cover the risk and there is no profit as such. But a proprietary society, of course, invests its income and receives dividends from it. That is how it makes its money. The result is that in practice a proprietary company is not charged with tax on any trading profit but only on its investment income.

When you are dealing with life insurance companies resident in the United Kingdom, there is no difficulty about applying the Double Taxation Agreement to them. They are resident here and are taxed on their total investment income from the life fund, wheresoever this income is derived, and they are given credit for the tax paid by them in Australia on their Australian investments. But with an Australian society (or any company resident overseas) the position is different. Apart from the special tax which we have to consider, the only tax payable by it in the United Kingdom would be the tax on its investments here, and it could avoid paying tax in England by reducing its English investments to a minimum.

It could make nearly all its investments elsewhere. It was in order to avoid such a situation, so obviously unjust to English taxpayers, that a special tax was introduced. In 1915 it was enacted that life insurance companies, with head offices overseas, should pay tax on a figure calculated according to a prescribed formula. The formula was this: Take the total income which the company receives from its investments all over the world. Then divide this income up. Divide it into proportions according to the volume of business done in life insurance in this country compared with the business done overseas. (This proportion was usually to be ascertained by comparing the premiums received in this country with those received overseas.) By dividing the world investment income in those proportions, you arrive at a fair figure to represent the proportion applicable to the United Kingdom. The company was to be taxed on the figure so ascertained. These 1915 provisions were afterwards embodied in rule 3 of Case III of Schedule D, and I will refer to them as "the rule 3 provisions."

The critical question, as I have said, is: "What is the nature of this rule 3 tax? Is it a tax on the investment income of the company, or is it a tax on the profits of the business? For it needs must, I think, be put in one category or the other if this Double Taxation Agreement is to work on it. And it is to be remembered that the term "profits" must be given the meaning it has under English law, unless the context otherwise requires.

Apart from authority, I should have thought this rule 3 tax was a tax on investment income. It is not, of course, a tax on specific investments but it is a tax on a proportion of the world investment income, and that is surely a tax on investment income and not on business profits. In so holding, I should be in good company, for Rowlatt J. so regarded it in Equitable Life Assurance Society of the United States v. Hills. So did Dixon C.J., Fullagar and Menzies JJ. in Mutual Life and Citizens' Association v. Federal Commission of Taxation, who all took the view that "If you impose a tax on 10 per cent. of an amount which includes several items, you are imposing a tax on every item which is included in that amount."

But it is said that there is a decision of this House to the effect that it is not a tax on investment income but is a tax on the profits of the business. That decision is Inland Revenue Commissioners v. Australian Mutual Provident Society. I would draw the attention of your Lordships to the most unusual course which that case took. The question was how the tax under rule 3 was to be calculated when some of the investments of the society were in United Kingdom War Loan Stock which was exempted from any tax at all. Both parties - both the Crown and the society - proceeded on the footing that the tax under rule 3 was a tax on investment income and that the society must be given the benefit of this exemption.

The parties differed only as to the way in which the benefit should be calculated. The method adopted by the Crown commended itself to the court of first instance. The method adopted by the society commended itself to the Court of Appeal. But when the case reached this House, a new point was raised for the first time by the House itself. It was suggested that the tax under rule 3 was not a tax on investment income at all but a tax on profits, and accordingly that the society was not entitled to any benefit at all from the exempted investments and could make no deduction at all on that account. Neither party liked the point at all. The Crown (in whose favour it appeared to be) refused to take it. The Solicitor-General (Sir Frank Soskice Q.C.) said:

"It is not proposed to address the House on the question whether the wording of rule 3 is such as not to permit any deduction at all. The Crown does not, in any event, seek an order putting the respondents in a worse position than the order of the court of first instance."

In spite of the Crown's reluctance, the House was so convinced of the correctness of the point, which it had itself raised, that it decided that the society was not entitled to any exemption at all. The House did not, however, carry its point of view so far as to compel the Crown to accept an order it did not ask for. The House simply reversed the decision of the Court of Appeal and restored the judgment of the court of first instance.

Looking back on it now, with all the knowledge since acquired, it does seem a pity that the House insisted on its own point so strongly, for it has been turned to great advantage by the mutual societies as against the Crown. It recently compelled the High Court of Australia to decide a case contrary to its own better judgment: see Mutual Life and Citizens' Association v. Federal Commission of Taxation. It compelled the judges below in the present case to decide it as they did, and Parker L.J. went so far as to say that he was unable "fully to understand" the decision of the House.

And, as it happened, no doubt owing to the unusual course which was adopted, the House in 1947 was never referred to a very relevant decision of its own. It was never referred to the decision in New York Life Insurance Co. v. Styles, which holds that a mutual life assurance society does not make profits. That case is quite inconsistent with the notion that the tax under rule 3 is truly a tax on "profits" as that word is used in English law. At most it is a tax on a calculated figure that is "deemed to be profits" though not so in fact. It is to be treated "as being income," that is, as if it were income derived from the business, though not so in fact.

My Lords, I ask myself, What authority is to be given in these circumstances to the decision of this House in 1947? Is it to be followed from step to step regardless of consequences? Are we to hold that the tax under rule 3 is a tax on the profits of the business for all purposes, including the purposes of the Double Taxation Agreement, which this House never had in mind at all? I think not. The doctrine of precedent does not compel your Lordships to follow the wrong path until you fall over the edge of the cliff. As soon as you find that you are going in the wrong direction, you must at least be permitted to strike off in the right direction, even if you are not allowed to retrace your steps. And that is what I would ask your Lordships to do. I would invite your Lordships to say that the decision of this House in 1947 has no application to the meaning of the word "profits" in the Double Taxation Agreement. The tax under rule 3 is not a tax on the profits of the business within the meaning of that agreement but is rather a tax on income in the form of dividends and interest.

Just consider what would be the result of applying the 1947 decision here. If the society does make "profits" from its business, the Double Taxation Agreement says that it is to be taxed here, as if it were completely independent of the Australian head office and were dealing at arm's length with it. But, on this hypothesis, what is the result? If this society were here completely independent, then, being a mutual society, it would not make any profits so as to be chargeable under Case I, and furthermore, being established in this country, it would not be liable to tax under rule 3 at all, because that tax does not apply to independent establishments here. So the establishment here would not be liable to tax on profits at all. This cannot have been intended. It is quite contrary to the tenor of the Double Taxation Agreement which assumes that, if the society does make profits, some of those profits would be attributable to its establishment in the United Kingdom.

The true answer, to my mind, is that the society does not make any "profits" from its business within the meaning of the Double Taxation Agreement. But it has a world "investment income," and it can be taxed here under rule 3 upon a proportion of that income, and when it comes to pay Australian tax in Australia (on its world investment income) it will receive credit for the amount paid here under rule 3. If I am wrong, it means that the Australian society will no longer have to pay the tax it has paid under rule 3 for 30 years or more. It will have to pay no tax at all in return for the benefit of carrying on the business of life assurance in this country - but only tax on such investments as it may choose at its will to retain in this country. I do not think that this was the intention of the Double Taxation Relief Agreement between the United Kingdom and Australia.

I would therefore allow the appeal.

Appeal dismissed.