1940 (5) TMI 23 - HC - Income Tax

Summary

Issues Involved:
1. Computation of profits for income-tax purposes.
2. Issuance of shares at par value to employees.
3. Deductibility of forgone profits as trading expenses.
4. Relevance of previous legal precedents.

Issue-wise Detailed Analysis:

1. Computation of profits for income-tax purposes:
The primary issue is the computation of the profits of a trade carried on by a limited company for income-tax purposes. The respondent company, involved in diamond exploration, issued shares to employees at par value, which was below the market value. The company sought to deduct the difference between the market value and the par value of the shares as an expense in computing their profits for income-tax purposes.

2. Issuance of shares at par value to employees:
The company issued 6,000 shares at par value (5s. each) to employees, while the market price was significantly higher (2 3s. 9d.). The employees were assessed for income-tax on the premium value of the shares, treated as remuneration for their services. The company argued that this issuance should be considered a trading expense, as it was done to give employees a stake in the company's success.

3. Deductibility of forgone profits as trading expenses:
The company contended that the forgone profit (the difference between the market value and the par value of the shares) should be deductible as a trading expense. The argument was based on the premise that the company had effectively incurred an expense by not issuing the shares at a premium. However, it was noted that the company did not actually disburse any money or diminish its trading receipts by issuing shares at par.

4. Relevance of previous legal precedents:
The judgment referenced previous cases, such as Usher's Wiltshire Brewery, Ltd. v. Bruce and Weight v. Salmon, to determine whether the principles established in those cases applied to the current situation. In Usher's Case, it was held that rent forgone by letting tied houses at reduced rents was a deductible expense. However, the current case was distinguished from Usher's Case as the shares issued by the company were not an asset, and the company did not incur any actual expense or disbursement.

Judgment Analysis:

Viscount Caldecote (Lord Chancellor):
The Lord Chancellor emphasized that the company did not incur any trading expense by issuing shares at par. The company's capital remained intact, and no money was disbursed. The issuance of shares at par did not diminish the company's trading receipts, and thus, the company could not claim the forgone profit as a deductible expense. The decision in Usher's Case was not applicable as it involved actual disbursements, unlike the present case.

Viscount Maugham:
Viscount Maugham reiterated that the company did not receive or expend the sum of lb11,625 (the premium value of the shares). The issuance of shares at par was intended to give employees a share interest in the company, not to discharge a debt or liability. The company did not lose or part with any asset, and the issuance of shares at par did not affect the company's trading profits. The decision in Usher's Case was based on specific circumstances related to property and rent, which did not apply to the current case.

Lord Russell of Killowen:
Lord Russell emphasized that the company did not disburse any money or transfer any asset to the employees. The issuance of shares at par was a decision to induce employees to become shareholders, not a trading expense. The premium forgone could not be treated as money laid out or expended for the purposes of the trade. The decision in Usher's Case did not justify the deduction claimed by the company.

Lord Wright:
Lord Wright argued that if the company had used the shares to discharge a pre-existing debt for salary, the forgone profit could be considered a deductible expense. However, in the present case, the shares were issued to give employees an interest in the company, not to discharge a debt. The decision in Usher's Case was applicable as it involved the deduction of expenses incurred to promote the trade, but the current case did not involve any actual expense or disbursement.

Lord Romer:
Lord Romer stated that the company had the power to acquire the premium value of the shares but chose to issue them at par. The company did not part with any money, but it was poorer for releasing the power to acquire the premium. The decision in Usher's Case supported the view that forgone profits could be considered a deductible expense, but the current case did not involve any actual expenditure.

Conclusion:
The appeal was allowed by a majority, concluding that the company could not deduct the forgone profit as a trading expense. The issuance of shares at par did not involve any actual disbursement or expense, and the principles established in previous cases did not apply to the current situation. The company's trading profits were not affected by the issuance of shares at par, and thus, the forgone profit could not be treated as a deductible expense for income-tax purposes.