Scottish Court of Session Decisions

The Income-Tax Act 1842 (5 and 6 Vict. cap. 35), section 100, enacts—“And be it enacted that the duties hereby granted, contained in the Schedule marked (D), shall be assessed and charged under the following rules, which rules shall be deemed and construed to be a part of this Act, and to refer to the said last-mentioned duties, as if the same had been inserted under a special enactment.

Schedule (D)

Rules for ascertaining the said last-mentioned duties in the particular cases herein mentioned.

First Case

Rules

Second Case

Rules

Rules applying to both the preceding cases. First, in estimating the balance of the profits or gains to be charged according to either of the first or second cases, no sum shall be set against or deducted from … such profits or gains, for any disbursements or expenses whatever, not being money wholly and exclusively laid out or expended for the purpose of such trade, manufacture, adventure, or concern ………..”

This was a stated case taken at the instance of the Surveyor of Taxes for the City of Glasgow.

The case set forth—“At a meeting of the Commissioners for the General Purposes of the Income-Tax Acts, and for executing the Acts relating to Inhabited House Duties for the city of Glasgow, held at Glasgow on the 4th Day of December 1005,

“Stewarts & Lloyds, Limited (hereinafter referred to as ‘the company’), appealed against an assessment for the year ending 5th April 1006 on the sum of £172,770 (duty £8638, 10s.) made upon it under Schedule D of the Income-Tax Acts, in respect of the profits of the business carried on by it, after allowing a deduction of £14,760 for wear and tear of machinery.

The assessment was made under 5 and 6 Vict. c. 35, sec. 100, Schedule D, First Case; 16 and 17 Vict. c. 34, sec. 2, Schedule D; and 5 Edw. VII, c. 4, sec. 6.

1. The following facts were admitted or proved—1.…

2. The objects of the company, as set forth in the third article of its memorandum of association, are, inter alia, as follows:— ‘ .… .( h) To enter into partnership, or into any arrangement for sharing profits, union of interests, reciprocal concession, or co-operation with any person or company carrying on or about to carry on any business which this company is authorised to carry on, or any business or transaction capable of being conducted so as directly or indirectly to benefit this company, and to take, or otherwise acquire and hold, shares or stocks in, or securities of, and to subsidise or otherwise assist any such company, and to sell, hold, re-issue, with or without guarantee, or otherwise deal with, such shares or securities.’

3. The liability of the company falls to be adjusted by reference to the profits of the three years ended 31st December 1902, 31st December 1903, and 31st December 1904.

4. Wilsons and Union Tube Company, Limited (hereinafter referred to as the Wilsons Company), incorporated under the Companies Acts 1862 to 1898, and having its registered office at No. 5 Wellington Street, Glasgow, carry on a business similar to that of the company.

5. In arriving at the profits for the year ending 31st December 1904, the company claimed deduction of a sum of £841 paid to the Wilsons Company under minute of agreement, dated the 26th day of October and the 3rd day of November 1903, entered into and executed by and between the Wilsons Company and the company.… .

The Wilsons Company was not assessed to, and did not pay income-tax on, said sum of £841. ,

II. The company contended—(1) That the agreement was entered into and the payment of £841 was made solely for the purposes of its own trade, and that it might sell its goods at a better price, and that therefore the deduction claimed was a proper one to be made from gross profits; (2) That as the arrangement made with the Wilsons Company enabled the company to make larger profits, and to an extent exceeding the payment made to the Wilsons Company, it is unreasonable to assess the larger profits to the income tax, and not allow as a deduction the sum expended by the company to earn them; and (3) That the Wilsons Company had paid dividend to their shareholders from which they deducted income tax—partly with the £841.

III. The Surveyor of Taxes maintained—(1) That the payment of £841 was not expenditure incurred in earning the profits of the company, but was a payment made in consideration of the company being allowed to nominate a majority of the board of the directors of the Wilsons Company; (2) That it was not money wholly and exclusively laid out or expended for the purposes of the trade of the company, within the meaning of the first ride, applying to both the first and second cases of Schedule D, section 100, 5 and 6 Vict. c. 35 (Rhymney Iron Company, Limited v. Fowler [1896], 2 Q.B. 79, 3 Tax Cases 476); and (3) That the payment of £841 was merely an appropriation of profits earned by the company, which is required by the Income Tax Acts to pay income tax on the whole of its business profits irrespective of their destination (Mersey Docks and Harbour Board v. Lucas, 1883, 8 A.C. 891, 49 L.T.R. 781, 2 Tax Cases 25).

IV. The Commissioners, on a consideration of the evidence and arguments submitted to them, held that the payment of £841 by the company having been made for the purpose of its trade and that it might sell its goods at a better price was a proper deduction, and, accordingly, they allowed the deduction of £841 claimed by the company …”

The minute of agreement between Wilsons and Union Tube Company, Limited

Page: 813↓

(first parties), and Stewarts & Lloyds, Limited (second parties), referred to in the stated case, under which the payment of £841 was made to the first parties, provided, inter alia:—“( First) The first parties agree to elect to their board of directors, and to continue to elect from time to time, and to retain as directors, such persons as may be nominated by the second parties greater in number than the other directors of the first parties. It shall be optional to the first parties at any time to decline to elect or re-elect or retain the nominees of the second parties, but in the event of their doing so, all obligations incumbent on the second parties under this agreement shall immediately cease. The second parties may from time to time change their nominees, in which case those previously nominated, one or more, so changed, shall retire, and the new nominees take their place. (Second) So long as, and if when required, the requisite number of nominees of the second parties are elected to the board of the first parties, and retained members thereof, the second parties agree to pay to the first parties, half-yearly on 1st March and 1st September, whatever sum is required to pay or make up a half-year's dividend on the preference shares of the first parties, according to the balance at credit or debit as shown by their balance sheets, to be made up as at thirtieth June and thirty-first December, half-yearly, and duly audited, i.e., if the profit shown by the balance sheet is less than two thousand five hundred pounds, the second parties shall make up the deficiency to the first parties, and if there be no profit at the credit of profit and loss account, or if there be a debit, the second parties shall pay to the first parties the sum of two thousand five hundred pounds. But declaring that in ascertaining such credit or debit there shall not be taken into account any loss carried forward from a preceding half-year, but merely the loss, if any, arising on the half-year's trading taken by itself. The first payment shall, if required, be made on the first day of March nineteen hundred and four. The balance at debit or credit of profit and loss account shall, for the purpose of this agreement, be ascertained by the auditors of the first parties. It is hereby expressly declared that the liability of the second parties in each half-year shall not exceed the sum of two thousand five hundred pounds.…”

The case came before the First Division.

Argued for the appellant (the Surveyor of Taxes)—The sum in respect of which deduction was claimed did not fall under Rule 1 applying to both the First and Second Cases under Schedule D, sec. 100, of the Income Tax Act, 1842—Dowell's Income Tax Laws, 5th ed., p. 152 — but under Rule 3 applying to the First Case—Dowell, ut supra, p. 145—and it was therein enacted that such payments were not to be deductible. But taking Rule 1 applying to both First and Second Cases, deduction was claimed here in respect of a disbursement not wholly or exclusively incurred for Stewarts & Lloyds' benefit, and necessary to the earning of their trade profits. Disbursements to be deductible must be directly concerned with the production of the article manufactured or its distribution, and not mere indirect aids to trading facilities— Watney v. Musgrave, L.R., 5 Ex. D. 241, 1 Tax Cases, 272—or must be for the purposes of carrying on a business, not an insurance against loss in the event of its profits ceasing or diminishing— Rhymney Iron Company Limited v. Fowler, [1896] 2 QB 79, 3 Tax Cases, 476; Brickwood & Company v. Reynolds, [1898] 1 QB 95,3 Tax Cases, 600, per Pollock (B), 604. The expenditure under consideration was not of a character for which deduction could be claimed in view of these decisions. Further disbursements necessary to earn profits might be deducted, but this was an application of profits already earned— Strong & Company, Limited v. Woodifield, [1905] 2 KB 350, per Collins (M.R.), 356. Nor was the result of the expenditure necessarily to earn a profit; the company might have to recoup Wilsons Company for loss owing to general depression of business or imprudent trading. It was in their power to have specially arranged only to pay when loss was the result of keeping up prices for their mutual benefit, but they had not done so. In certain circumstances the agreement might even be against the company's earning increased profits. There was no case where a payment of this character, which was not for making or putting on the market the goods manufactured, but was for preventing a loss, or for creating a state of the market through the transactions of a rival business, had been held deductible.

Argued for the respondents—The finding of the Commissioners showed that in fact the expenditure in respect of which deduction was claimed was made for the purposes of profit-earning in their trade, and it was wholly and exclusively for these purposes in the meaning of Rule 1 applying to First and Second Cases under Schedule D, sec. 100, of the Income Tax Act 1842. It was to be noted that the rule did not use the word “necessary” in prescribing the nature of deductible expenses, but merely observed a distinction between outlay to earn profit and the application of profit earned— Mersey Docks v. Lucas, L.R., 8 A.C. 891, per Lord Selborne (L.C.), 903, In the present case the earning of increased profit was the only possible motive for the expenditure, so the rule laid down by Collins (M.R.) in Strong & Company, Limited v. Woodifield, ut supra, p. 356, was in their favour. The true meaning of the words “profits or gains” in commercial trading was laid down in The Gresham Life Assurance Society v. Styles, [1892], A.C. 309, per Lord Halsbury (L.C.), 316, and that of the “profit of trade” was defined in Russell v. Town and County Bank, April 26, 1888, 15 R. (H.L.) 51, Lord Herschell, 52, 25 S.L.R. 451. These definitions showed that the expenditure here was deductible, and that the amount was not assessable to income tax. As to the cases quoted for the appellants, the Rhymney Iron Company, Limited v. Fowler, ut, , was distinguished, for in the present case a working agreement was of importance to the company. Pollock (B) laid it down in Reid's Brewery Company v. Male, [1891], 2 Q.B. 1, p. 8, 3 Tax Cases, 279, that the case of Watney v. Musgrave, ut supra, went too far, and that argument had been accepted by the Bench in the case of Southwell v. Savill Brothers, Limited, [1901] 2 KB 349. Every authority supported the proposition that any expenditure necessary for earning profit, or without which profit would not have been gained, falls to be deducted before assessing profits for income tax, and that was the character of the payment in question. The whole question was indeed primarily one of fact, the agreement could not be considered per se aid the finding of the Commissioners who had considered the full facts was conclusive since there was no error in law proved. The agreement was to further the trading interests of the company, though benefit might accrue to the Tube Company thereby, and consequently the sum paid there under should be deductible in calculating income tax.

At advising—