1942 (2) TMI 14 - HC - Income Tax

Summary

Issues Involved:
1. Construction of the contract with Martins Bank.
2. Reasonableness of the company's contract with the bank.
3. Distribution of a reasonable part of the company's income.
4. Onus of proof regarding the distribution of income.

Issue-wise Detailed Analysis:

1. Construction of the contract with Martins Bank:
The core issue was whether the contract with Martins Bank prevented the appellant company from distributing dividends. The Board of Referees held that it would not have been a breach of contract for the company to distribute a dividend. The Court agreed that the contract did not bind the company not to distribute a dividend. The company could use income-receipts to discharge a capital liability or purchase a capital asset, and then pay a dividend out of other cash or by borrowing, as explained in Montague Burton, Ltd. v. Inland Revenue Commissioners.

2. Reasonableness of the company's contract with the bank:
The Board of Referees found that if distributing a dividend would have breached the contract, it was not reasonable for the company to make such a contract. However, the Court found this irrelevant because the contract was not attacked as unreasonable. The Solicitor-General admitted that it was not part of the Revenue's case that the company should not have entered into the bank agreement. The contract was a genuine business arrangement, and the company's actions were controlled by it.

3. Distribution of a reasonable part of the company's income:
The Special Commissioners directed that the company's income for the years 1936-37 and 1937-38 should be deemed the income of the members for surtax purposes, which was reversed by the Board of Referees and then restored by the Court of Appeal. The Court found that the Board of Referees misdirected themselves in concluding that the company had not distributed a reasonable part of its income. The Board's view that the company should have managed its affairs to provide for dividend distribution was not supported by evidence. The company's decision not to distribute dividends was reasonable given the bank agreement.

4. Onus of proof regarding the distribution of income:
The Court held that the onus of proof was on the Revenue to show that the company acted unreasonably in withholding part of its income from distribution. The Board of Referees misdirected themselves regarding the onus of proof, assuming that the company had to prove it could not have made a better bargain. The facts did not support the conclusion that the company failed to distribute a reasonable part of its income. There was no evidence that it was commercially possible for the company to borrow funds to distribute dividends without jeopardizing its interests.

Conclusion:
The appeal was allowed with costs. The Court found no evidence to support the Board of Referees' finding that the company failed to distribute a reasonable part of its income. The decision of Macnaghten, J., was restored, and the order of the Court of Appeal was set aside. The company's actions were reasonable given the genuine business arrangement with the bank, and the onus was on the Revenue to prove otherwise, which they failed to do.