9911796707
TMI Blog1964 (6) TMI 56X X X X Extracts X X X X X X X X Extracts X X X X ..... he respondent's members was confirmed; and the effect of the order of the Chancery Division (affirmed by the Court of Appeal) was to discharge the direction which had been made upon the footing that the respondent was an investment company within the meaning of section 257 of the Act of 1952. The question in issue in this appeal was whether the respondent was for the period in question an investment company within the meaning of section 257, it being common ground that the validity or otherwise of the direction made upon the respondent depended on the answer to that question. The following facts were found by the special commissioners in the case stated. The respondent was incorporated on August 19, 1954, with a share capital of 100 divided into 100 shares of 1 each, which were held as follows during the relevant period: Leonard Lever and his wife May Lever as trustees (as from October 19, 1954) 38 Leslie Lavy and his wife Rita Lavy as trustees (as from January 18, 1955) 15 J.H. Howard (transferred to Mr. and Mrs. Lever, February 4, 1955) 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Securities on hand-March 31, 1955 s. d. Quoted 28,814 10 6 Unquoted 424,114 7 10 452,928 18 4 Gross loss carried down 895,487 8 3 1,483,773 6 7 By Dividends Received Quoted Securities s. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ut them to, their market value at March 31, 1955, being estimated as follows: B. Co. Wool Merchants (Bradford) Ltd. 146,769; Cranwell (Holdings) Ltd. 252,345; N.E.T. Holdings Ltd. 25,000, making a total of 424,114. In due course the respondent made a claim for repayment of tax under the provisions of section 341 of the Income Tax Act, 1952, which was admitted in the sum of 404,020, of which 250,000 was repaid on December 14, 1955, and 154,020 on February 28, 1958. On January 22, 1960, the special commissioners issued a direction to the respondent in the following terms: Whereas it appears to the Special Commissioners of Income-tax that F.S. Securities Ltd. (formerly Federated Securities Ltd.) is an investment company to which section 245 of the Income Tax Act, 1952, applies, the Special Commissioners of Income Tax hereby give notice that they direct that for purposes of assessment to surtax, the actual income of the said company from all sources for the period from September 1, 1954, to March 31, 1955, shall be deemed to be the income of the members and the amount thereof shall be apportioned among the members.... It was contended on behalf of the responden ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the dividends received by the company, such dividends were nevertheless trading receipts of the company's trade inasmuch as they satisfied the definition of earned income provided in section 525(1)(c), i.e., they were 'income which is charged under Schedule B or Schedule D and is immediately derived... from the carrying on or exercise...of [the company's] trade...' If this were correct, the company would not fall within the definition of investment company in section 257(2)...We do not think that this argument is well founded. On the authorities cited to us, in particular Hughes v. Bank of New Zealand** and Cenlon Finance Co. Ltd. v. Ellwood***, it seems to us that dividends cannot be charged to tax under Schedule B or Schedule D and cannot, therefore, be regarded as earned income within the terms of the definition contained in section 525(1)(c). Moreover, the company's primary object in purchasing the shares in the three companies subjected to the 'dividend stripping' operation was to obtain the dividends, i.e., the income arising from the shares, and not to deal in the shares themselves, which could only have been sold at a loss after the operations ha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 57 of the Act of 1952. The question in issue in this appeal was whether the respondent was for the period in question an investment company within the meaning of section 257, it being common ground that the validity or otherwise of the direction made upon the respondent depended on the answer to that question. The following facts were found by the special commissioners in the case stated. The respondent was incorporated on August 19, 1954, with a share capital of ?100 divided into 100 shares of ?1 each, which were held as follows during the relevant period : Leonard Lever and his wife May Lever as trustees (as from October 19, 1954) Leslie Lavy and his wife Rita Lavy as trustees (as from January 18, 1955)15 J.H. Howard (transferred to Mr. and Mrs. Lever, February 4, 1955)1 J.D. Collinson (transferred to Mr. and Mrs. Lever, February 4, 1955)1 The directors of the respondent were Leonard Lever, Leslie Lavy and one Yablon, and the respondent carried on the business of a finance company. The memorandum of association of the respondent contained, inter alia, the following objects for which the respondent was established: To carry on the business or businesses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 424,114 7 10 452,928 18 4 Gross loss carried down 895,487 8 3 1,483,773 6 7 By Dividends Received Quoted Securities s. d. (Gross) 3,043 2 7 Unquoted Securities (Gross) 1,686,198 12 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14, 1955, and ? 154,020 on February 28, 1958. On January 22, 1960, the special commissioners issued a direction to the respondent in the following terms: Whereas it appears to the Special Commissioners of Income-tax that F.S. Securities Ltd. (formerly Federated Securities Ltd.) is an investment company to which section 245 of the Income Tax Act, 1952, applies, the Special Commissioners of Income Tax hereby give notice that they direct that for purposes of assessment to surtax, the actual income of the said company from all sources for the period from September 1, 1954, to March 31, 1955, shall be deemed to be the income of the members and the amount thereof shall be apportioned among the members.... It was contended on behalf of the respondent that the respondent was not an investment company within the meaning of section 257(2) of the Income Tax Act, 1952, to which the provisions of section 245 of the Income Tax Act, 1952, applied; and therefore, the direction dated January 22, 1960, of the special commissioners was incorrect in law, and, accordingly, that the appeal should be allowed and the direction discharged. It was contended on behalf of the Crown that the respon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the definition of investment company in section 257(2)...We do not think that this argument is well founded. On the authorities cited to us, in particular Hughes v. Bank of New Zealand* and Cenlon Finance Co. Ltd. v. Ellwood**, it seems to us that dividends cannot be charged to tax under Schedule B or Schedule D and cannot, therefore, be regarded as earned income within the terms of the definition contained in section 525(1)(c). Moreover, the company's primary object in purchasing the shares in the three companies subjected to the 'dividend stripping' operation was to obtain the dividends, i.e., the income arising from the shares, and not to deal in the shares themselves, which could only have been sold at a loss after the operations had been carried out and which in fact were never sold or otherwise disposed of. It seems to us that in these circumstances, apart from the question of law to which we already referred, the nature of the income is more akin to investment income than to trading income. In our opinion the company falls to be regarded as an investment company within the meaning of section 257(2) of the Income Tax Act, 1952...In the final result the directio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nting double taxation, it is submitted that the House should be slow to disturb a practice which has subsisted for a very long time and the existence of which has been accepted by subsequent legislation. [Reference was made to sections 122, 123, 127(1), 184, 185, 186, 341(1)(3) and 342(1)(4) of the Income Tax Act, 1952.] Viscount Simonds' dictum in Cenlon Finance Co. Ltd. v. Ellwood* that it had always been the practice to include taxed dividends in the computation of profits taxable under Case I was made per incuriam. Affidavit evidence given in Rex v. Commissioners of Income Tax for the City of London** shows that it was, as long ago as 1904, the practice of the income tax authorities to exclude dividends taxed at source from the computation of the trader's profits under Case I, but it was argued in that case for the Crown that, although such dividends were left out of account for the purpose of computing a profit, they ought to be brought into account for the purpose of ascertaining whether a loss had been incurred, and approval of this argument was expressed by Lord Alverstone C.J. As a result it was the practice from 1904 till 1937 to include taxed dividends in a tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd to adopt either of them would be in conflict with the provisions of those Acts. Generally, the principle of Fry v. Salisbury House Estate Ltd.(4) is applicable here: see per Lord Atkin. As to the comparable position in respect of interest on Government bonds which have suffered deduction of tax under Schedule C, see Thompson v. Trust and Loan Co. of Canada(5), per Lord Hanworth M.R. [Reference was also made to Griffiths v. J.P. Harrison (Watford) Ltd.(6); Argosam Finance Co. Ltd. v. Oxby.(7)] F. Heyworth Talbot Q.C. and H. Major Allen for the respondent company. The question is: do these taxed dividends come into the computation of the trading profits of this company? In considering whether it is a trading receipt it is irrelevant whether the dividend be taxed or untaxed. In the Cenlon case* the House of Lords held that the dividends in question there were trading receipts. If those receipts were trading receipts, what principle of discrimination excludes the present dividends which have suffered tax from being classed as trading receipts? The Cenlon decision* is plainly applicable here and, accordingly, all the dividends received by the company in the relevant period must ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st, 1954, with a capital of 100 ? 1 shares. At the relevant period 83 of these shares were held by two persons as trustees. The main object of the company was to carry on the business of stock and share dealers. Its most important venture was to purchase in December, 1954, and March, 1955, the entire share capital of three companies for sums amounting in all to ? 1,317,565. It financed these purchases by borrowing from its bankers 93 per cent. of the value of these shares. These three companies held large amounts of accumulated profits which had borne tax, and soon after purchasing them the respondent caused them to declare dividends amounting to ? 927,408 net after deduction of tax or ? 1,686,198 gross. The respondent then prepared a profit and loss account for income tax purposes for the period from September 1, 1954, to March 31, 1955. This showed a loss of ? 895,487. This loss was arrived at by putting on the one side of the account the purchase price of the securities and on the other side the value of these securities after the dividends had been paid, leaving out of the account the dividends which were paid to the respondent. The respondent then submitted a claim under se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... spondent ought not to have been repaid anything under section 341 but the respondent has not offered to repay the sum of ? 404,020. So the question now in issue is the question how a dealer in stocks and shares ought to treat dividends accruing to him from shares which he has bought in the course of his trade. It was decided in Cenlon Finance Co. Ltd. v. Ellwood* that a capital dividend which is not paid under deduction of income tax must enter his profit and loss account and the respondent maintains that the same rule must apply to dividends paid under deduction of tax. The question how dividends paid under deduction of tax fall to be treated for income tax purposes has a long history. I dealt with that matter in my speech in the Cenlon case*, but anything said in that case about dividends paid under deduction of tax was obiter because the question before this House related solely to dividends which had not borne tax, and I certainly did not have in mind any case like the present. So I have carefully reconsidered what I said in that case, but on reflection I see no reason to alter it. I said**: I find it necessary to start from the ordinary case of a dividend paid out of pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... after the assessable profit has been determined. Let me suppose that a trader in stocks and shares has received ? 5,000 net in dividends which have borne tax. The respondent's counsel concedes that in order to make his scheme work it is necessary to bring in not the net sum which the trader actually received but the gross amount of the dividends. If the standard rate were 10s. in the pound, the gross amount would be ? 10,000 and it is that sum which the respondent says must be brought into the account. Then suppose that apart from such dividends the trader has made a profit of ? 4,000. On the respondent's view, the profit and loss account will show a profit of ? 14,000 and tax on that at such standard rate would be ? 7,000. But that would plainly involve double taxation of the same dividends. He would have suffered deduction at source of ? 5,000 and he would have to pay another ? 5,000 by reason of the gross dividends having swollen his profit and loss account. So the respondent says that the trader must be entitled to deduct from the ? 7,000 tax assessed under Schedule D, Case I, the sum of ? 5,000 which has already been deducted as tax before he receives the dividend. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . If these dividends do not even enter into the computation of the respondent's profits for the purposes of Schedule D, they are plainly not charged under Schedule D and are, therefore, not earned income within the meaning of section 525. But then it cannot be denied that they were income of the respondent, and they were by far the largest part of its income. If they were not earned income then they must come within the definition of investment income in section 257. It follows that the respondent was an investment company within the meaning of that section and that the only ground of appeal against the decision of the special commissioners fails. I am, therefore, of opinion that this appeal must be allowed and that the question of law in the case stated should be answered in the affirmative. VISCOUNT RADCLIFFE. My Lords, there is only one issue in this appeal, whether the respondent company is an investment company within the meaning of section 257 of the Income Tax Act, 1952. If it is, a direction issued to it on January 22, 1960, by the Special Commissioners of Income Tax, requiring that for purposes of surtax assessment its actual income from all sources for the per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of dividend current for the year, represented ? 1,686,198. The operation left the shares much reduced in value, and, as they were still held by the respondent at March 31, 1955, they were entered in its trading account as an item of stock in hand at a market value of ? 424,114 pound in all. The respondent treated itself as having suffered a trading loss for the period to the amount of ? 895,487, almost entirely made up of the loss on these three items, and put in a claim to the Inland Revenue under section 341 of the Act on the basis that, having suffered this loss in its trading income account, it was entitled to relief pro tanto from the tax that had been taken by deduction from the dividends on its three blocks of investments. The dividends, the ? 927,408, had not been entered, either net or gross, in the account of its trading income. Had they been, there would have been no loss and no claim for repayment of tax under section 341. The claim for loss relief was admitted in accordance with the current practice, and a sum of ? 404,020, representing tax on the ? 895,487, was repaid to the respondent by two payments, one in December, 1955, and the other in February, 1958. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... favour with the Court of Appeal owing, I think, to a mistaken application of a recent decision of this House in a case Cenlon Finance Co. Ltd. v. Ellwood* I must now address myself to it. We have, then, to suppose that the respondent, instead of being a limited company, was operating its finance company business as an individual and carrying out the same operations as have been carried out here. If one were asked the bare question whether in making up the trading account of such a man it would be right to bring in interest and dividends received on the stocks and shares that he was dealing in, I should think that the answer would certainly be Yes. In principle it seems to be the way to arrive at a full and fair statement of his profit or loss. Whether there is a case for grossing up the sums received so as to write into the account the income tax deducted on payment I am not at all clear. It looks like importing into the account which, ex hypothesi, is being drawn up for general purposes and not those of income tax assessment, a conception which really belongs to the working of the income tax system and the peculiarities that it engenders. But that point is not material for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s beneficiary the net amount of the trust income that has borne tax in his hands. Dividends which represent the distribution of a taxed fund are therefore franked income so far as concerns any further taxation at the standard rate, that is, the rate at which deduction has been made; while, for the purposes of administering reliefs against tax at standard rate and of assessing to surtax, it is proper to treat the net sum received as grossed up in the way that the statute (Income Tax Act, 1952, s. 184) requires. This account of the status of dividends in the tax system is in line with the analysis offered by Lord Phillimore in Bradbury v. English Sewing Cotton Co. Ltd.*, where he points out that the Income Tax Act, 1842, the basic instrument of our income tax code, treated a joint stock company as if it were a large partnership, so that the payment of income tax by a company would discharge the quasipartners**. In my opinion, this analysis is now accepted as being correct: and it remains essential to the application of the whole system even though the connection between any particular fund of profits and a dividend paid has now become in effect untraceable and the rule that the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... misconception. The matter has been looked into carefully since the Cenlon decision was made public, and counsel for the Inland Revenue have assured us that their researches contradict the existence of any such practice. Counsel for the respondent, speaking from an exceptional range of experience, confirmed the novelty of the assumption made in Cenlon**. I think that we must take it that it has been long-established and regular practice to exclude taxed interest and dividends from the computation. The practice with regard to finance companies was so stated in an affidavit which is reported as having been placed before the court in Rex v. Commissioners of Income Tax for the City of London* which contained a paragraph: 12. The income tax authorities always insist upon dealing separately with such investments upon which the income tax is deducted at the source, and excluding the same from the profits of the trade for the purposes of assessment thereof under Schedule D, and I believe they have the right to do so... The court's decision does not deal with the propriety or otherwise of such a method of estimating assessable profits, but there does not seem to have been any dispute a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act tax is to be charged under Cases I and II of Schedule D on the full amount of the profits or gains. That has no effect on the principle of computation. The rule of excluding income which has been assessed to tax under its own title from insertion as an item in an assessment under Case I of Schedule D was recognised and given effect to by this House in the well-known Salisbury House decision* (rents from land) and again by the Court of Appeal in Thompson v. Trust and Loan Co. of Canada** (interest on Government bonds). The principle is clearly stated in the first case*** in the speeches of Viscount Dunedin and of Lord Atkin, and in the second case# in the judgment of Lord Hanworth M.R. I regard the decision in Hughes v. Bank of New Zealand Ltd.## as an enforcement of the same principle. In the last case the exclusion was the product of the positive statutory enactment that the War Loan interest was to be free of tax. In the other two cases it was produced by the fact that the income which it was sought to include in the Schedule D assessment had borne its appropriate tax under another Schedule, Schedule A or Schedule C. Does it make any difference in the application of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt. Nothing that I have said, therefore, involves any critical comment on the Cenlon decision* as confined to such dividends. It was, of course, appreciated when it was said that dividends taxed at source ought to enter into the computation of a dealer's trading profits that this would involve taxing the same income twice over, a procedure that is normally regarded as unfair and unacceptable. To avoid the practical consequence of this, however, it was suggested in the Cenlon case* that there was some equitable principle that could be invoked against the revenue which would compel an adjustment of the tax bills on the two forms of taxed income. How far such an equity is to take the taxpayer is not stated, so I am afraid that I cannot tell whether it is an equity not to suffer more tax than that payable under the larger of the two bills or to have the tax on the dividends returned pro tanto, even though there is no trading loss. With respect to those who have invoked this principle, however, I am quite unable to see where it comes from. It seems to me merely an illegitimate way of trying to mitigate the consequences of a wrong principle. It is one thing to say that the Inco ..... X X X X Extracts X X X X X X X X Extracts X X X X
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