Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes)

[1972] 1 All ER 681

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Between: Odeon Associated Theatres Ltd
And: Jones (Inspector of Taxes)

Court:

Judges: Salmon LJ
Buckley LJ
Orr LJ

Subject References:
TAXATION
INCOME TAX
Deduction in computing profits
Trade expenses
Repairs
Deferred repairs
Acquisition of cinema in poor repair
Cinema fully capable of commercial use
Vendor's failure to repair before acquisition
Vendor precluded by war time restrictions from carrying out repairs
No diminution in price in respect of disrepair
Deferred repairs begun two years after acquisition
Repairs spread over several years
No indication of extra cost over and above cost of ordinary repairs
Expenditure on deferred repairs charged to revenue account as separate item from expenditure on current repairs
Expert evidence on accountancy practice
Finding that charging to revenue according with accountancy practice
No conflict with statute
Conclusiveness of finding
Whether expenditure on deferred repairs capital or revenue expenditure for income tax purposes
Whether deductible in computing profits

Legislative References:
Income Tax Act 1952 - s 137

Case References:
Bidwell v Gardiner - (1960) 39 Tax Cas 31; 28(1) Digest (Reissue) 194, 603
British Insulated and Helsby Cables Ltd v Atherton - [1926] AC 205; [1925] All ER Rep 623; 95 LJKB 336; 134 LT 289; 10 Tax Cas 155; affg CA sub nom Atherton v British Insulated and Helsby Cables Ltd [1925] 1 KB 421; 28(1) Digest (Reissue) 211, 627
BSC Footwear Ltd (formerly Freeman, hardy & Willis Ltd) v Ridgway (Inspector of Taxes) - [1971] 2 All ER 534; [1971] 2 WLR 1313; Digest Supp
Comr of Taxes v Nchanga Consolidated Copper Mines Ltd - [1964] 1 All ER 208; [1964] AC 948; [1964] 2 WLR 339; 28(1) Digest (Reissue) 204, 677
Highland Railway Co v Balderston (Surveyor of Taxes) - (1889) 2 Tax Cas 485; 28(1) Digest (Reissue) 201, 652
Inland Revenue Comrs v Granite City Steamship Co Ltd - 1927 SC 705; 13 Tax Cas 1; 28(1) Digest (Reissue) 202, 658
Jackson (Inspector of Taxes) v Laskers Home Furnishers Ltd - [1956] 3 All ER 891; [1957] 1 WLR 69; 37 Tax Cas 69; 28(1) Digest (Reissue) 192, 594
Law Shipping Co Ltd v Inland Revenue Comrs - 1924 SC 74; (1923) 12 Tax Cas 621; 28(1) Digest (Reissue) 599, 1480
Lothian Chemical Co Ltd v Rogers (Inspector of Taxes) - (1926) 11 Tax Cas 508; 28(1) Digest (Reissue) 202, 657
Ostime (Inspector of Taxes) v Duple Motor Bodies Ltd - [1961] 2 All ER 167; [1961] 1 WLR 739; 39 Tax Cas 537; affg CA sub nom Duple Motor Bodies Ltd v Inland Revenue Comrs [1960] 2 All ER 110; [1960] 1 WLR 510; 28(1) Digest (Reissue) 125, 371
Regent Oil Co Ltd v Strick (Inspector of Taxes) - [1965] 3 All ER 174; [1966] AC 295; [1965] 3 WLR 636; 43 Tax Cas 1; affg CA sub nom strick (Inspector of Taxes) v Regent Oil Co Ltd [1964] 3 All ER 23; [1964] 1 WLR 116; 28(1) Digest (Reissue) 183, 552
Roebank Printing Co Ltd v Inland Revenue Comrs - [1928] SC 701; [1927] 13 Tax Cas 864; 28(1) Digest (Reissue) 207, 685
Royal Insurance Co v Watson - [1897] AC 1; 66 LJQB 1; 75 LT 334; 3 Tax Cas 500; 28(1) Digest (Reissue) 185, 562
Stott v Hoddinott - (1916) 7 Tax Cas 85; 28(1) Digest (Reissue) 180, 542
Sun Insurance Office v Clark - [1912] AC 443; [1911-13] All ER Rep 495; 81 LJKB 488; 106 LT 438; 6 Tax Cas 69; 28(1) Digest (Reissue) 134, 398
United Steel Cos Ltd v Cullington - [1940] 2 All ER 170; [1940] AC 812; 109 LJKB 342; 163 LT 42; 23 Tax Cas 91; 28(1) Digest (Reissue) 460, 1658
Usher's Wiltshire Brewery Ltd v Bruce - [1915] AC 433; 84 LJKB 417; 112 LT 651; 6 Tax Cas 418; 28(1) Digest (Reissue) 130, 383

Hearing date: 18-20 October 1971
Judgment date: 3 November 1971

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The taxpayer company were members of one of the biggest groups of companies engaged in the cinema industry and carried on a substantial business as exhibitors of films. In 1945 they bought a cinema, one of a large number which they acquired in the immediate post-war period. Owing to war time restrictions it had been impossible for the vendors, in common with other cinema owners, to spend more than comparatively small sums on keeping the cinema in repair. During the previous five years therefore many repairs and replacements which would normally have been effected had been deferred. However at the date of its acquisition the cinema was a fully effective profit earning asset and the price paid by the taxpayer company was not affected by reason of the lack of repair. From 1945 to 1954 the taxpayer company spent substantial sums of money on repairs and renewals at the cinema. For the purposes of excess profits tax the taxpayer company treated part of that expenditure in their accounts as revenue expenditure on current repairs and, from 1947 on, treated the remaining part as revenue expenditure on deferred repairs and renewals, ie as constituting the expenditure necessitated by the failure to carry out repairs during the war time period. It was contended by the Crown that the expenditure on deferred repairs and renewals was not revenue but capital expenditure and was therefore not deductible in ascertaining the taxpayer company's profits for income tax purposes. On appeal to the Special Commissioners the taxpayer company called expert evidence of accountants, which the commissioners accepted, that the items were properly chargeable to revenue in accordance with established principles of sound commercial accounting.

Held

(i)

The money expended by the taxpayer company on the deferred repairs was laid out wholly and exclusively for the purposes of the taxpayer company's trade within s 137(a) ^[F1] of the Income Tax Act 1952 and not partly for the purposes of the trade of the company from which the cinema had been acquired; for the same reason the money had been 'actually expended' on repairs for the purposes of the taxpayer company's trade within s 137(d) (see p 690 b to d, p 696 a and p 697 f, post);

(ii)

The expenditure was not capital expenditure within s 137(f) and (g) for the following reasons-

(a)

the expenditure was by nature revenue and not capital expenditure and would have been deductible as such if the original owner of the cinema had remained the owner and had incurred it (see p 688 h, p 692 j to p 693 a and p 698 b, post);

(b)

as the commissioners had held that it was in accordance with established principles of sound commercial practice to charge the disputed items to revenue expenditure and not capital and as those principles in no way conflicted with any statute the court would, in the absence of any rule of law to the contrary, adopt and apply those principles in deciding the case (see p 691 b, p 692 a, p 696 g and p 698 h, post);

(c)

owing to the inability of the vendors, in common with all other owners, lawfully to execute the repairs in the period before acquisition, the purchase price of the cinema had in no way been affected by its disrepair at the date of acquisition (see p 691, g, p 693 a and p 698 g, post);

(d)

the cinema was a profit-earning asset at the date of its acquisition in spite of its disrepair and remained so for several years thereafter although no money was spent (or could be spent) on deferred repairs during some of those years (see p 691 h, p 693 b and p 695 b, post);

(e)

(per Buckley and Orr LJJ) it had not been established that the taxpayer company had been put to any greater expense in the way of repairs and redecoration by reason of the deferred repairs than would have been the case if there had been no deferred repairs (see p 695 g and h, and p 698 j to p 699 b, post);

Law Shipping Co Ltd v Inland Revenue Comrs (1923) 12 Tax Cas 621 distinguished.

Per Curiam

If the deferred repairs on the cinema had been properly chargeable as capital expenditure, such repairs would have been so chargeable in respect of cinemas acquired (a) from an outside vendor with succession, and (b) as the result of a transfer within the taxpayer company's group of companies without succession or (c) with succession; the source from which the taxpayer company acquired the cinemas, and whether with or without succession, was not relevant to the question (see p 692 d f and g, p 696 g and p 699 e and f, post).

Decision of Pennycuick V-C [1971] 2 All ER 407 affirmed.

Notes

For the deduction of trade expenses in computing profits generally, see 20 Halsbury's Laws (3rd Edn) 158-170, paras 277-292, and for cases on the subject, see 28(1) Digest (Reissue) 141-158, 421-505.

For deductions for the cost of repairs, see 20 Halsbury's Laws (3rd Edn) 173, 174, paras 300-302 and for cases on the subject, see 28(1) Digest (Reissue) 169-171, 515-520.

For the application of accountancy principles in computing profits, see 20 Halsbury's Laws (3rd Edn) 139, 140, para 247.

For the Income Tax Act 1952, s 137, see 31 Halsbury's Statutes (2nd Edn) 134. Section 137 has been replaced by s 130 of the Income and Corporation Taxes Act 1970.

Appeal

The taxpayer company, Odeon Associated Theatres Ltd, appealed to the Special Commissioners against assessments to income tax made on them as cinema proprietors under Sch D to the Income Tax Acts 1918 and 1952 in the following sums: 1946-47, £75,000; 1947-48, £150,000; 1948-49, £328,000; 1949-50, £587,600; 1950-51, £370,000; 1951-52, £510,000; 1952-53, £340,000; 1953-54, £350,000; 1954-55 £375,000; and 1955-56, £400,000. The grounds of appeal were that in computing for income tax purposes the profits or gains of the taxpayer company for the accounting periods relevant to the assessments there should be allowed as an expense sums expended by the taxpayer company as repairs to certain cinemas owned by them which could be related to the condition of the cinemas at the time of their acquisition by the taxpayer company. The taxpayer company appealed by way of case stated against the commissioners' decision. The following facts are taken from those found by the commissioners in the case stated (the paragraph numbers being those of the case):

'5.

Odeon Theatres Limited had achieved its position as the third largest circiut during the 1930's, both by building new theatres and buying existing theatres and theatre owning companies. War time restrictions put an end to building and the only way the circuit could be expanded was by buying theatres and theatre owning companies ...

'6.

Where the directors were considering acquiring a theatre otherwise than from within the Group, the normal procedure was that Mr. Davis would ask the firm of Messrs. Goddard & Smith to prepare a valuation. Mr. Davis would then have discussions with the partner responsible and in the light of these discussions would subsequently conduct negotiations with the theatre's owner, for its possible acquisition. Mr. Davis understood that a valuation was made as between a willing buyer and a willing seller and related purely to the circumstances affecting the particular theatre. Mr. Davis expected Messrs. Goddard & Smith in making these valuations to take account of the general factors affecting the profitability of the theatre such as its location, capacity and facilities. Although Messrs. Goddard & Smith had acted for the Odeon Group for a considerable number of years and attended meetings at which operating policy decisions were taken on acquisitions, Mr Davis did not expect them to advise in the light of all the various considerations on which the operating policy was based and indeed they were not in a position to do so. Mr. Davis naturally used the valuation as a base price in the course of negotiations but as a commercial operator he had to take into account those factors which were peculiar to the Group's needs and the overriding factors of the prospective increase in booking strength. The result was that the purchase price was sometimes more and sometimes less than the valuation. In particular, if a capital deduction was made in the valuer's report because of a theatre's poor state of repair, it would not have had a material effect on the price the Group was prepared to pay for the following reasons:

(a)

The overall necessity to expand the number of theatres owned, particularly those in London and other urban areas, and consequently to improve the Group's booking strength.

(b)

During the second would war there was a complete prohibition on building, decorating and repair work of any kind except for essential maintenance and even then the consent of the Ministry of Works was required. Each theatre was granted an annual permit to carry out essential maintenance work up to a stated amount. The amounts varied from as little as £75 to £800 per annum but in any event were totally inadequate to keep the theatres in a proper state of repair. In addition a Supplemental Licence was required to carry out any specific work costing more than £100. Theatres rightly had a low priority in securing Supplemental Licences. The result was that no one in the industry was in a position to carry out work of this type apart from such minor essential repairs as could be covered by the annual permit. If a theatre was in a poor state of repair on acquisition, the effect on public attendance was minimal, since all competing theatres were in a similar state. (c) For the most part the deficiencies were not of a nature requiring immediate remedy. There was no question of danger to the public or of any theatre having to be closed for repairs. (d) Building restrictions continued in force until the early nineteen-fifties. During the war, when negotiations for the acquisition of the Odeons, Accrington and Marble Arch and other theatres were taking place Mr. Davis foresaw this was likely to happen and as a result did not pay so much attention to a theatre's state of repair as might otherwise have been the case. The type of work necessary to put these theatres into a first class of repair was maintenance and repair work, which in normal circumstances is carried out continuously. Mr. Davis's attitude was that in the normal course the theatres would be redecorated when the restrictions were removed, but that the same work would not be done twice merely because the period since maintenance work was last carried out was much longer than normal. As a result the deduction from purchase price, which might otherwise have been made, was ignored. If the directors had not bought others would have bought on a similar basis ...

'8.

During the immediate post-war period there was a financial rationalisation programme for the Odeon Group ... It was necessary to approach the market in stages so the theatres owned or controlled by the Odeon Group were divided amongst three companies, Odeon Theatres Limited, Odeon Properties Limited and Odeon Freehold and Ground Rents Limited now called Odeon Associated Theatres Limited [("the taxpayer company") which was a wholly-owned subsidiary of Odeon Theatres Ltd] ...

'12.

In the period under review the consideration payable on inter-group transfers was computed by reference to the transferor company's books of account ...

'15.

Expenditure classified as capital in the Statements of Fact [annexed to the case stated] represented additions or improvements to the condition of the theatre. The whole of such expenditure was charged to capital, no deductions being made from the companies' profits for tax purposes.

'16.

Expenditure classified as current repairs and renewals in the said Statements of Fact were such as could not be treated as attributable to user of the theatre during the E. P. T. [ie excess profits tax] period and accordingly no relief was allowed against this tax [i e EPT]. These repairs and renewals were charged in their entirety to trading account and were deducted from profits in income tax computations.

'17.

All items of expenditure listed in the Statements of Fact as charged to deferred repairs account were to some extent attributable to user of the theatre during the E. P. T. period. Deferred repairs and renewals were treated in the same way as current repairs and renewals and were charged in their entirety to trading account.

'18.

According to standard practice of commercial accounting in relation to groups of companies, whether a theatre with outstanding deferred repairs is transferred from one member of the group to another the best method would be to take it out of the transferor company's balance sheet at its written down book value irrespective of the amount of the deferred repairs and to take it into the balance sheet of the transferee company at the same value, thus the consolidated group balance sheet would show to increase in total assets ...

'19.

It was contended on behalf of the [taxpayer company]:-(i) that in computing for income tax purposes the profits or gains of the [taxpayer company] for the accounting periods relevant to the assessments under appeal there should be allowed as an expense sums expended by the [taxpayer company] on repairs (hereinbefore referred to as "deferred repairs") to cinemas owned by it, notwithstanding that such expenditure could be related to the condition of the cinemas at the time of their acquisition by the [taxpayer company] ...

'20.

It was contended by the [Crown]:-(i) that in computing for income tax purposes the profits or gains of the [taxpayer company] for the accounting periods relevant to the assessments under appeal no allowance fell to be made for sums expended by the [taxpayer company] on repairs (hereinbefore referred to as "deferred repairs") to cinemas owned by it which related to user prior to the acquisition of such cinemas by the [taxpayer company] ...

'21.

We, the Commissioners who heard the appeal, gave our decision in the following terms:-(1) [Having set out the nature of the appeal they continued:]

The grounds of the appeal are that in computing for Income Tax purposes the profits or gains of the [taxpayer company] for the accounting periods relevant to the assessments under appeal, there should be allowed as an expense suspended by the [taxpayer company] on repairs to certain cinemas owned by it which related to user prior to the acquisition of such cinemas by the [taxpayer company] ...

'(3)

The [taxpayer company] and associated companies owned a large number of cinemas which have been divided for purposes of this appeal into four categories. ^[F2] After acquisition the [taxpayer company] carried out repairs to each of these cinemas some of which repairs it is admitted properly related to user prior to the acquisition of the property by the [taxpayer company] and for convenience these are referred to as deferred repairs.

'(4)

the evidence given in chief by the witnesses is not really controverted by the Crown and it seems to us, therefore, that there is no real dispute as to the facts in this case. The parties are agreed that in the hands of the vendors there was no capital element in the deferred repairs and so far as the [taxpayer company] was concerned there was no diminution in price on account of the deferred repairs which are in issue in this appeal.

'(5)

The real dispute in this appeal seems to us to be whether expenditure on assets which, if it had been incurred by the vendor, would have been allowable in computing the profit or gain of a trade carried on by the vendor for the purpose of arriving at his liability to tax would, if in fact incurred by a purchaser of that asset, be allowed in computing the profit or gain of a trade carried on by the purchaser for the purposes of arriving at his liability to tax and if not, whether it makes any difference if the purchaser in addition to buying the asset, also succeeds to the trade carried on by the vendor in which that asset was used, or that there is no allowance in respect of such expenditure in the purchase price.

'(6)

It is not a trade which is assessed to tax, it is a person. If a person carries on a trade, the measure of his liability to tax is the profit or gain derived by him from carrying on such trade. Expenses of a trade which accrued prior to the carrying on of that trade by the person presently to be taxed cannot be taken into account in determining the profit or gain derived by him for the purpose of ascertaining his liability to tax. Such expenses did not accrue in the process of earning his profit or gain and if paid by him they are not revenue expenses, but something over and above, and therefore capital. It is nothing to the point that had such expenses been incurred in earning somebody else's profit or gain they might have been allowed as a revenue expense. It seems to us that this is the proposition which stems from the Law Shipping case ^[F3] upon which all the judges in the Court of Session were unanimous, and also the Granite City Steamship Co. case ^[F4] which cases are binding on us. Furthermore, in the light of the cases cited it seems to us that it makes no difference if there is a succession or if there is no allowance from the price of the asset purchased.

'(7)

It was also put to us that since the Companies Act of 1948 the consolidated accounts required in the case of a group of companies, by the provisions of Sections 150, 151 and 152 of the Companies Act, 1948, would, if produced on sound commercial principles, necessarily involve that the cost of deferred repairs should be eliminated from the Balance Sheet by charging such cost to revenue accounts. This may be so, but we do not think that a form of accounts required for the purposes of the Companies Act, 1948, is conclusive as to what items may be properly charged to reveue in computing profits or gains for Income Tax purposes.

'(8)

Our decision is, therefore, that this appeal fails in principle and we adjourn the appeal for the agreement of the amounts of the assessments between the parties on the basis of our decision set forth above.'

On 26 November 1969 the case was remitted by the Chancery Division to the commissioners as follows:

'THIS COURT ORDERS that the said Case be remitted to the Special Commissioners for them to make and state in a Supplemental Case a finding on th following question, viz:-

'On the assumption that all theatres with which this Case is concerned were acquired from vendors outside the group but that all other facts were as found in the existing Case Stated, how, in accordance with the principles of sound commercial accounting would the disputed expenditure be dealt with in the purchasers accounts?'

By the supplemental case the commissioners gave the following decision:

'Upon consideration of the evidence adduced at the Meeting and the arguments addressed to us on behalf of the parties and the publication "Practical Auditing" by Spicer and Pegler (15th Edition), which was cited to us, we found that on the assumption that all theatres with which this case is concerned were acquired from vendors outside the Group but that all other facts were as found in the principal case stated, in accordance with the principles of sound commercial accounting at the present time the disputed expenditure referred to in the principal case as the "deferred repairs" would be dealt with as a charge to revenue in the purchasers accounts.'

On 12 November 1970, as reported at ([1971] 2 All ER 407), Pennycuick V-C allowed the taxpayer company's appeal against the commissioners' decision, holding that the taxpayer company were entitled to deduct the cost of the deferred repairs in computing its profits for income tax purposes. The Crown appealed to the Court of Appeal.

The Solicitor General (Sir Geoffrey Howe QC), R A Watson QC and P W Medd for the Crown.

Heyworth Talbot QC, M P Nolan QC and Denis Carey for the taxpayer company.

Cur adv vult

3 November 1971. The following judgments were delivered.