Willingale and International Commercial Bank LTD

[1978] AC 834

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(Judgment by: Lord Russell of Killowen)

Willingale (Inspector of Taxes)
and International Commercial Bank LTD

Court:

Judges: Lord Diplock
Lord Salmon
Lord Fraser of Tullybelton

Lord Russell of KillowenLord Keith of Kinkel

Subject References:
Revenue
Corporation tax
Computation of profits
Anticipated profits from bills and promissory notes discounted or purchased by bank
Whether tax payable on fractional part of anticipated profits from bills

Legislative References:
Income and Corporation Taxes Act 1970 - Section 108

Case References:
BSC Footwear Ltd v Ridgway - [1972] AC 544; [1971] 2 WLR 1313; [1971] 2 All ER 534
Duple Motor Bodies Ltd v Inland Revenue Commissioners - [1961] 1 WLR 739; [1961] 2 All ER 167
Gardner, Mountain and D'Ambrumenil Ltd v Inland Revenue Commissioners - (1947) 177 LT 16; [1947] 1 All ER 650; 29TC69
Harrison v John Cronk and Sons Ltd - [1937] AC 185; [1936] 3 All ER 747
Newcastle Breweries Ltd v Inland Revenue Commissioners - (1927) 96 LJKB 735; 12 TC 927
Southern Railway of Peru Ltd v Owen - [1957] AC 334; [1956] 3 WLR 389; [1956] 2 All ER 728
Sun Insurance Office v Clark - [1912] AC 443
Bennett v Ogston - (1930) 15 TC 374
Dailuaine-Talisker Distilleries Ltd v Inland Revenue Commissioners - [1930] SC 878; 15 TC 613
Dimbula Valley (Ceylon) Tea Co Ltd v Laurie - [1961] Ch 353; [1961] 2 WLR 253; [1961] 1 All ER 769
Odeon Associated Theatres Ltd v Jones - [1971] 1 WLR 442; [1971] 2 All ER 407; [1973] Ch 288; [1972] 2 WLR 331; [1972] 1 All ER 681
Pearce v Woodall Duckham Ltd - [1977] 1 WLR 224; [1977] 1 All ER 753
Seaham Harbour Dock Co v Crook - (1930) 16 TC 333
Whitworth Park Coal Co Ltd v Inland Revenue Commissioners - [1961] AC 31; [1959] 3 WLR 842; [1959] 3 All ER 703

Hearing date: December 7 - 8 1977; February 2 1978
Judgment date: 2 February 1978

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Judgment by:
Lord Russell of Killowen

My Lords, I approach the problem in this case in three stages.

First: suppose a transaction in which A (by way of his trade) advances to B a sum of money to be repaid at the expiration of three years with simple interest thereon at a rate per centum per annum, the obligation to pay the interest being, however, postponed to the date for repayment of the loan. The question arises whether the interest is to be brought into computation of A's trading profits for tax purposes in each of the three years of its accrual, or not until on the date fixed for payment of principal when three years interest becomes payable. I defer the answer to that question.

Second: the answer to the first question cannot be different if the interest payable is compound rather than simple. This seems to me to be clear. Compound interest accrues annually no less than simple interest.

Third: what is the essential nature of the transaction selected by my noble and learned friend, Lord Fraser of Tullybelton, from page 48 of the record? The bank provides finance of £63.1, against a promise by the acceptor of the bill to pay £100 at the expiration of six years. The difference between the two sums (referred to as a convenient label as discount) can on analysis only be attributable to interest on the finance provided at eight per cent. per annum for each of the six years compounded with yearly rests. It is not commercially realistic to regard the make-up of the "discount" as anything else - as a figure plucked from the sky. (The straight line treatment in the bank's accounts of £6.15 annually is a convenient simplification: strictly to represent the discount in terms of accrual of compound interest at eight per cent. p.a. would involve figures varying from approximately £5.05 in the first year to approximately £7.41 in the sixth.)

Accordingly in my opinion the problem in this case is thrown back to that which I have described as the first stage plus the distinguishable difference of the second stage: for I see no essential distinction between that and the third stage.

Before reverting to the first stage, I set aside from consideration as immaterial the fact that many relevant bills or notes were in non-sterling currencies. In such cases the resulting profits in sterling (and tax) terms might fluctuate: but that could not affect for tax purposes the question whether the "growth in value" of a bill in any year was in principle a relevant profit or gain of that year.

I set aside also from consideration that there may and will be fluctuations in interest rates. The interest rate upon which a "discount" was based would not be altered by such fluctuation. I do not therefore consider that in the solution of the present problem there is a relevant uncertainty under those heads, any more than an uncertainty whether the acceptor will be good for the money in the end, with possibly a bad debt later to be written off. Prima facie the expiration of time per se adds annually to the entitlement of the bank.

The argument for the Crown is that, the accounts of the bank being based upon sound commercial accounting practice - as they are - they are to be accepted for tax purposes as showing the profits of the trade year by year, unless they are in conflict with some requirement or principle of tax law. The bank accepts this, but contends that this conflict exists, inasmuch as there is conflict with the principle that for tax purposes there must be no anticipation of profits. For this principle the bank appealed to the statements of Lord Reid and Lord Morris of Borth-y-Gest referred to by my noble and learned friend, Lord Fraser of Tullybelton. At the same time the bank firmly disclaimed any attempt to depart from the principle of taxation law that profits "earned" in a particular year are for tax purposes profits or gains arising or accruing to the trader in that year; and also disclaimed any assertion of liability to tax only upon a cash receipts basis.

Accordingly the answer to the question posed by me at the outset of my opinion (the first stage) depends upon what is meant by "anticipation of profit": what is meant by "earnings." Neither is a word of universal application in the same sense in all circumstances. In that sense they are imprecise, and cannot be an instant solution to every problem. Nevertheless the question may be posed at that first stage: is a profit earned in year 1 though payment of the amount is deferred by reason of the terms of the commercial transaction until year 3? In my opinion it is so earned, and the treatment of it as a profit of that year is not a relevant (and forbidden) anticipation of profit. In the example given at the outset of this opinion (the first stage) it is, I consider, correct to say that in year 1 the finance afforded, or loan, earned in that year interest at X per centum. At the end of that year time had passed upon the basis of which the lender become entitled to a sum of X per centum on the amount of his loan, and nothing could deprive him of the fruits of that entitlement save default of the borrower, which would require ultimate adjustment for a bad debt in the ordinary way. I can well understand a ban on anticipation of profits for tax purposes when, for example, a trader buys goods with a view to future sale on a virtually certain rising market: if they are stock-in-trade there are of course special rules: but, if they be not, there is no time-plus-annual-interest element in the appreciation in value as there is in the case of the chose in action considered at the first stage of this opinion.

It follows from what I have said that in my opinion the computed interest which is the content of the "discount" on a bill is not anticipated by being brought in as an annual profit or gain in respect of its periods of accrual. This applies equally whether the bill or note was acquired from the original acceptor or by subsequent purchase: the reason is that the difference between the face value of the bill and the cost of acquisition inevitably represents as a commercial matter compound interest. A money lender in the case of a loan on what I have called an original bill would be hard put to it to deny that.

These, my Lords, I believe to be, though doubtless not so well expressed, the reasons which led Stamp L.J. to dissent in his judgment, and I agree with him.

The burden of the argument for the bank was that the difference between the cost of a bill and the amount due on maturity is not interest: the bill is one chose in action providing for one sum due on maturity and can show no profit until maturity or earlier sale: consequently to treat any part of the difference (discount) as a profit or gain arising or accruing in any fiscal period before one of those events is anticipation of profit not permitted by principles of tax law. But if my analysis of the essential make-up of the "discount" is correct, that contention is not correct.

Now it is true that the accounting method of the bank does not with precision reflect the attribution of the compound interest composition of the discount, because of the adoption for convenience and simplicity of the straight line method. But it is common ground that that method is commercially acceptable, and it does not seem to me to conflict with any principle of tax law.

In the course of argument it was suggested that if the Crown were correct it would lead to the conclusion that the whole of the "discount" should be brought in as an earning in the fiscal year in which the bill or note was acquired, though at a reduced figure to reflect deferment for (in the example given) six years. I do not accept that suggestion.

But for one matter I would accordingly allow the appeal and remit the matter to the commissioners for decision upon the basis of the bank's accounts. The one matter is that the bank advanced an alternative contention that the bills and notes should be regarded as stock-in-trade. I should have thought that contention difficult to support: in most cases the bank advanced money on original bills to hold to maturity. But this question was not ruled upon by the commissioners and it would have to be remitted to them. However, since the majority of your Lordships are for dismissing the appeal the question does not arise.