England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL

		7th February 1927

Income Tax, Schedule D, Case I—Business carried on abroad —Control—Profits of trade—Deduction.

Under its Articles of Association the management of a Company of insurance brokers registered in England was vested in its Board of Directors in London, with powers of delegation. One of the Directors was appointed Resident Director in France, and conducted the French business of the Company from an office in Paris under a power of attorney from the Company. He attended a few Board meetings in London, though not bound to do so. He also made some reports to the other Directors, and on one or two occasions received their concurrence with his proposals, but they did not interfere with his conduct of the French business. Separate accounts of that business were kept in Paris, but the results were incorporated in the balance sheets of the Company, though no part of the French profits was ever remitted to London.

The Company contended that the control of the Paris business was in Paris and not in London, and that the profits therefrom were accordingly not assessable to Income Tax.

The Company also claimed as a deduction from its profits for Income Tax purposes, a sum of £19,200 payable (by instalments) to a retiring Director in the following circumstances.

The original Directors were appointed for life so long as they held a qualifying number of shares, subject to dismissal forthwith for neglect or misconduct towards the Company. A Director so dismissed was only entitled to receive Jus salary then due and could be required to sell his shares to the other Directors at par. He would also have to surrender for cancellation certain notes issued by the Company entitling him to participate in surplus profits.

Circumstances arose in 1920 and 1921 in which the Company might possibly have been justified in dismissing one of the Directors, but, to avoid publicity injurious to the Company's reputation, it entered into negotiation with him for his retirement He claimed £50,000 compensation, but a compromise was arrived at and embodied in an agreement dated the 30th December, 1921, by which he agreed to retire from the Company, to transfer his 300 £1 shares to the other Directors at par value (they were then worth considerably more) and to surrender his participating notes. The Company agreed to pay him £19,200, and the Directors to pay him £300 (expressed to be consideration for his shares), making together £19,500 (payable in five annual instalments), which he agreed to accept in full satisfaction of all claims against the Company or the Directors.

The Special Commissioners on appeal decided against the Company on the question of the control of the French business, but in their favour on the question of the deduction of the said sum of £19,200. A Case for the opinion of the High Court was demanded both by the Company and by the Crown.

Held,

(1) that the control of the Company's Paris business was with the Board of Directors in London, that their authority was not divested by the power of attorney to the Paris Director, and that the Company was accordingly assessable to Income Tax in respect of its Pa-is profits under Case I of Schedule D (Egyptian Hotels, Limited v. Mitchell, 6 T.C. 152 & 542, distinguished);

and (2) that the instalments of the sum of £19,200 payable by the Company to the retiring Director under the agreement of the 30th December, 1921, were admissible deductions in arriving at its profits for Income Tax purposes.

Case

Stated under the Income Tax Act, 1918, Section 149, by the Commissioners for the Special Purposes of the Income Tax Acts for the opinion of the King's Bench Division of the High Court of Justice.

1. At a meeting of the Commissioners for the Special Purposes of the Income Tax Acts held on the 11th day of July, 1924, for the purpose of hearing appeals, B. W. Noble, Ltd., hereinafter called the Company, appealed against three assessments to Income Tax in the sum of £10,475 for the year ending 5th April, 1924, £7,500 for the year ending 5th April, 1923 and £3,411 for the year ending 5th April, 1922, made upon them in respect of the said years.
2. (a) The Company, which was a private company, was incorporated on the 11th December, 1916, for the following purposes (inter alia) :—

(i) To acquire and carry on the business of an Insurance and Re-Insurance Broker and Agent previously carried on by Major Noble in London.

(ii) To carry on business as Fire, Life, Accident, Third Party, Burglary, Contingency, Employers Liability, Marine or any other Insurance or Re-Insurance Brokers and Agents for and London Managers of the business of any British, Colonial or Foreign Insurance or Re-Insurance Company, and any other trade or business whatsoever which can, in the opinion of the Board, be advantageously carried on by the Company in connection with or as ancillary to the general business of the Company.

A copy of the Memorandum and Articles of Association of the Company are hereto annexed marked " A " and form part of this Case.^[1]

(b) By an agreement dated 15th December, 1916, Major Noble agreed to sell and the Company to purchase the said business carried on by Major Noble, and by a further agreement of the same date and made between the Company and Major Noble, it was agreed that Major Noble should act as Managing Director of the Company upon the terms and conditions therein contained. Copies of the said two agreements marked " B " and " C " respectively are annexed hereto and form part of this Case. ^[2]

(c) Under the Articles of Association of the Company the first directors of the Company were Major Noble, Mrs. Noble and Mr. Haylor. Major Noble was appointed Chairman and Managing Director, and as such he was entitled to preside at any General Meeting of the Company.

In the material period the Company had issued 500 Preference shares and 1,000 Ordinary shares of a nominal value of £1 each. The Preference shares, which were held with the exception of one share by Mrs. Noble, Major Noble's wife, did not carry with them any title to vote. The Ordinary shares were, in the period, held as follows :—

Major B. W. Noble	500
Mr. C. E. Haylor	300
M. Gabus	200
	1,000

The holders of these shares, of which Major Noble held half the total number issued, were entitled to vote at Shareholders' Meetings, and Major Noble as Chairman was entitled, upon equal division of opinion among the shareholders, to a casting or deciding vote.

3. Since its incorporation the Company has carried on the business of an insurance and re-insurance broker and agent in the manner and to the extent hereinafter set out. The insurance business done by the Company has been a brokerage business consisting of placing insurances for clients, mainly against risks of fire, for a commission payable to it as broker upon the work done. The re-insurance business has been done for a limited number of companies, for which it acts as Manager and agent in accordance with Letters of Appointment and Powers of Attorney granted to it by such companies. The nature of this work appears more fully hereafter in paragraph 5 of this Case.
4. Major Noble's business was commenced in or about the year 1913 and in the year 1915 or 1916 he first obtained business from Paris carrying out such business at his London Office. This business consisted entirely of brokerage business and arose through French brokers sending risks to be placed in London. The Company was anxious to extend this business and Monsieur Gabus, who had first been employed by Major Noble on salary and commission in October, 1916, and who had an important general business connection in England and France, was made a Director of the Company in April, 1919. Sometime in 1919 it was also suggested to the Company by one or two of the companies for which it did re-insurance work in London and by certain leading British offices for which no such work had been done that it should open an office in Paris for the purpose of representing them there. In pursuance of these objects on 1st September, 1919, resolutions were passed by the Directors which were recorded in their minutes as follows :—

The proposal to open offices in Paris was fully discussed and ultimately on the motion of the Chairman seconded by Mr. Haylor it was unanimously resolved—

" That a branch office of the Company be opened in Paris as soon as possible in order that the Company may adequately represent British Companies in France and increase and improve the present brokerage and re-insurance business of the Company there.

On the motion of the Chairman seconded by Monsieur Gabus it was further resolved that—

Mr. C. E. Haylor be requested to proceed to Paris with one other Director for the purpose of selecting an Office and organising the same and

That a sum not exceeding £1,000 be reserved for travelling and other expenses incidental to the formation and organisation of the Paris Office."

5. In accordance with the above resolution Mr. Haylor went over to Paris, took offices, and did the preliminary work of opening the Paris office in the name of the Company and staying in Paris about two months. The business in Paris was at first conducted through a Manager (Mr. O'Neill) who resided permanently in Paris, under the superintendence of one or other of the Directors of the Company who visited Paris from time to time and held powers of attorney to act on behalf of the Company.

When the Paris Office was opened it was the intention of the Company to continue and extend the French brokerage business which (as stated in paragraph 4 hereof) had previously been done from London. But when the Company opened the Paris Office and commenced to do business there it found that the conditions under which Fire Insurance business was conducted in France did not permit of brokerage and direct insurance business being conducted there by the same person. The Company gave an undertaking to the President of the French Chamber of Brokers not to do brokerage business. Accordingly during the years material to this appeal the Company's business in Paris was confined to doing direct insurance business on behalf of the companies for whom it acted as Agents. Some business was got through Paris brokers who offered the Company risks, paying the usual brokerage charges. The Company itself did no brokerage or re-insurance business. Recently, however, the Company has taken over a re-insurance business in Paris formerly conducted by a Monsieur Regard and the Company now does re-insurance work in Paris.

During the material years the Company represented some of the same companies both in London and Paris, the only difference being that in Paris the agreements were for direct insurance, whereas in London they did general insurance business including re-insurance. The terms of remuneration, limits of risks, etc., were similar both in London and Paris.

As illustrative of the arrangements between the Company and the companies for whom it acted as agents either in England or in France the following documents which were produced to us are hereto annexed marked as indicated below and form part of this Case.

" D." (1) A resolution of L'Internationale Belge Societe Anonyme de Reassurances et de Co-Assurances of 17 May, 1919, authorising an account to be opened in London.^[3]

(2) Letter of appointment of the Company as British Managers of the Belgian company dated 30th April,

1919. ^[4]

(3) Power of attorney from the Belgian company to the Company dated 22nd April, 1919. (1)

" E." Agreements to act as agents in France for the following companies—

(1) Caledonian (dated 21st October, 1919)

(2) West of Scotland 6th

(3) Scottish 25th September ,,

(4) Royal London 30th October „

(5) Garantia 22nd October, 1919

(6) Die Kjobendavnske (Copenhagen) 11th October, 1919.

The agreements with the Caledonian and other Scottish companies were negotiated by Monsieur Gabus in England or Scotland and were executed in England.^[5]

" F." (1) Power of attorney from the Nippon Fire Insurance Co., Ltd., to the Company dated 1st March, 1920. (1) (2) Specimen forms of (a) interim guarantee, (b) guarantee policy and (c) note paper of the Company as agents of the Nippon Fire Insurance Co., Ltd. of Tokyo. ^[6]

" G." Power of attorney from the Nippon Fire Insurance Co., Ltd. to Messrs. Gabus, Haylor & Noble dated 24th December,

1920, and 4th March, 1921. ^[7]

" H." Power of attorney from the Royal London Auxiliary Insurance Co., Ltd. to Messrs. Noble, Haylor, Silver & Gabus dated 24th January, 1921. ^[8]

" I." Power of attorney from the City of London Insurance Co., Ltd. to Messrs. Noble, Haylor, Silver & Gabus dated 9th March, 1921. ^[9]

" J." Power of attorney from the Southern Union General Insurance Company of Australasia, Limited to Messrs. Noble, Silver & Gabus dated 10th March, 1922. ^[10]

" K." Letter of appointment of the Company as agents for France for the Southern Union General Insurance Company of Australasia, Limited dated 10th March, 1922. ^[11]

6. The arrangements at first made for carrying on business in Paris through a Manager proved unsatisfactory and in January, 1920, the Manager's services having been dispensed with, Monsieur Gabus went to Paris to reside there permanently to conduct the French business of the Company. Since that date Monsieur Gabus has had the sole conduct of the French business holding a power of attorney to act on behalf of the Company.

A copy of this power of attorney, which was sealed by the directors in London at a meeting held on 13th February, 1920, is annexed hereto marked " L " and forms part of this Case. At the same meeting powers of attorney in identical terms were executed by the Company in favour of the other directors, namely Major Noble and Mr. Haylor. At the same meeting the Company executed a power of attorney in favour of two of their staff to act as Chief Clerks of the Paris Office. A copy of the last mentioned power of attorney marked " M " is annexed hereto and forms part of this Case.^[12] The first power of attorney granted to Monsieur Gabus did not meet the requirements of the French Board of Trade, for example registered letters could not be delivered to Monsieur Gabus because they were in the name of the Company. Accordingly a second power of attorney in favour of Monsieur Gabus was prepared in Paris by the Company's Solicitor, and executed by the Company in London on 15th December, 1920, a copy of which is annexed hereto marked " N " and forms part of this Case. Monsieur Gabus was appointed Resident Director in France and was relieved from attendance at Board meetings in London. He has, on a few occasions, attended meetings of the Directors in London and reports have been received by the Directors from him as to the progress of the business, and he has, on one or two occasions, received their concurrence with his proposals.

Apart from the occasions upon which he attended Directors' meetings in London, Monsieur Gabus from time to time came over from Paris to the London Office and on these occasions usually occupied the greater part of his time in interviewing the representatives of the principal British companies for whom the Company acted as agent in Paris.

From time to time Major Noble went over to Paris to see a French company for whom the Company acted in London, and on these occasions called to see Monsieur Gabus at the Paris Office, but did not interfere with the work at that Office.

Monsieur Gabus had special knowledge of insurance business in France not possessed by the other Directors and the Paris business conducted by him did not pass through the London Office. The other Directors have not interfered with the conduct by M. Gabus of the Paris business and by reason of their inexperience of French Insurance matters are not competent to do so. The Paris business derived its income from French business done by it, and its accounts were kept in Paris separate and apart from those of the London Company, but the results of Paris business were incorporated in the balance sheets of the Company. No part of the French profits were ever remitted to London.

The following documents which were produced in evidence before us are hereto annexed, marked as under, and form part of this Case, namely—

"0." Extracts from the Minute Book of the Company of meetings of Directors held on various dates between 1st September, 1919, and 9th March, 1921, inclusive. (It was stated in evidence that Monsieur Gabus was present at the meetings held on 1st, 15th and 17th September, 1919, 23rd March. 1920, 25th November, 1920, but was not present at the remaining meetings).

"P." Copy of Minutes of Annual General Meetings of the Company and of meetings of the Directors, of various dates between 26th May, 1921, and 4th July, 1923, inclusive. ^[13]

" Q." Copy of balance sheet and profit and loss accounts of the Company for the year ended 30th September, 1922. ^[14]

7. Under an agreement of the 25th November, 1918, a copy of which marked " R " is annexed to and forms part of this Case, made between the Company and its Directors, namely Major Noble, his wife, C. E. Haylor and M. E. Gabus it was provided, inter alia, that the Directors should be Directors for life so long as they should continue to hold a qualifying number of shares, subject to dismissal for misconduct as mentioned below. In the event of a Director being so dismissed the remaining Directors were empowered to require him to sell to them his shares in the Company at par.

Further, under this agreement, the salaries of the directors for the first year were fixed at—

£2,000 to Major Noble,

£1,750 to Mr. Haylor and

£1,500 to Monsieur Gabus,

and it was provided that although these figures might be varied from time to time, having regard to the profits of the Company, the ratio should remain the same.

It was also provided that if any director should (inter alia) neglect his duties or be guilty of such misconduct towards the Company or otherwise as would in the absence of any agreement to the contrary entitle a company to summarily dismiss a director so offending from his employment, the Company should have, power to dismiss him forthwith paying to him such a proportion! of his salary only as should then be due. In the event of a director being so dismissed the remaining directors were empowered to require the director dismissed to sell his shares to them at par. It was also provided that upon the determination of the agreement from any cause whatever none of the directors should without the consent of the Company engage in any business similar to that of the Company within 3 miles of the City of London, for three years from' the determination of the agreement.

8. By a further agreement of 29th April, 1920, a copy of which marked " S " is annexed to and forms part of this Case,^[15] made between the Company, its Directors and Mr. Silver, a new Director, the Directors covenanted to alter the Company's Articles so as to enable the Company to issue Participating Notes, and it was provided that as soon as this was done the Company would create 2,000 of these Notes and allot 500 to Major Noble, 300 to Haylor, 200 to Gabus and 150 to Silver. These Notes were to confer certain rights in profits the material provision being that in each year the surplus profits of the Company should be applied as follows : First, in payment of a dividend of £5 per share on the Ordinary shares of the Company ; half of the remaining profits to be divided rateably between the holders for the time being of the Ordinary shares of the Company, and the other half between the Participating Note holders, in proportion to the number of Notes held by them. It was provided that no persons other than a Director, officer, servant, or employee of the Company should be entitled to hold or acquire Participating Notes. It was also provided that when a Note holder ceased to be a Director, officer servant or employee of the Company, he should forthwith surrender his Notes to the Company to be cancelled. The necessary alterations in the Articles were made and the Notes were allotted as provided by the agreement.
9. During 1920 and 1921 considerable friction of a personal nature arose between Mr. Haylor and his co-Directors and there was evidence before us of conduct on the part of Mr. Haylor improper in a Director of the Company. The other Directors desired to get rid of him and considered it necessary for the sake of the good name of the Company to do so. It was admitted in evidence before us that the Company might possibly have been justified by law in exercising its power of dismissal, in which case Mr. Haylor would have been entitled to no compensation, but as the other Directors were very anxious that the matter should not become public, and that a scandal affecting the reputation of the Company should be avoided, they entered into negotiations with Mr. Haylor for his retirement. He at first demanded £50,000, but a compromise was eventually arrived at, and on 30th December, 1921, an agreement was entered into between the Company, the remaining Directors and Haylor, whereby Haylor agreed (1) to retire from the Company (2) to transfer his shares, which at this time were 300 £1 shares, at their face value of £1 per share to the remaining Directors and (3) to surrender his Participating Notes. The Company agreed to pay Haylor £19,200 and the Directors to pay him £300, making together the sum of £19,500, and Haylor agreed to accept that sum in full and complete satisfaction of all claims which he had or might have against the Company or the Directors. (The £300 paid by the Directors was expressed to be the consideration for his shares.)

The agreement also provided that notwithstanding the provisions of the agreement of 25th November, 1918 (above mentioned) Haylor should be at liberty to engage in a business of a similar nature to that of the Company, in the City of London and elsewhere. There were mutual covenants between Haylor and the remaining Directors not to repeat accusations or insinuations of improper conduct.

A copy of the said agreement is hereto annexed marked " T " and forms part of this Case.

It was given in evidence that these shares were in fact worth considerably more than their face value, but it was not possible to put an exact value upon them.

The issued capital of the Company was £1,000 and the dividends declared in the three years ended 30th September, 1922, averaged about 677 per cent the figures being as follows :—

Dividends Year ended	London	Paris	Total
30th September 1920	£3,000	Nil	£3,000
1921	£4,000	£4,995	£8,995
1922	£5,000	£3,319	£8,319

The above sum of £19,500 was payable in five annual instalments. The first instalment (which was duly paid) amounted to £5,500 and consisted of (a) the £300 payable by the Directors for Haylor's shares and (6) £5,200 being part of the £19,200 payable by the Company.

10. At a previous appeal by the Company on the 15th November, 1921, against an assessment to Excess Profits Duty, it was held by the Commissioners then sitting that the Company must be treated as carrying on a separate business in Paris ; that there was no inter-connection between the businesses carried on in Paris and in London respectively, and that they could not regard the fact that they were in common ownership and ultimately controllable (though not immediately controlled) by one body of shareholders and by one body of directors as sufficient to constitute them one business.
11. It was contended on behalf of the Company—

(a) That the business in Paris was for the purposes of Income Tax a business separate and distinct from the business in London and that this point had in fact already been decided by the Commissioners at the hearing in 1921 ;

(b) That the control of the Paris business was in Paris and not in London ;

(c) That the profits of the Paris business were not assessable to British Income Tax ;

(d) That the sum of £19,200 mentioned in paragraph 3 of this Case as payable to Mr. Haylor was money wholly and exclusively laid out for the purposes of the business, and that the instalments were admissible deductions from profits as and when they fell due.

12. It was contended on behalf of the Crown (inter alia):—

(a) That the question of whether, in the years under appeal, the Paris business was a separate business was not concluded by the previous decision of the Special Commissioners on the 15th November, 1921, but was to be determined upon the evidence before us. the Commissioners hearing this appeal;

(b) That the Company carried on one undivided insurance business ; that the work done in Paris and London respectively merely consisted of different activities of one general business; that the Paris Office was simply a " branch office " and was not a separate business ;

(c) That whether the Paris Office was a separate business or not, it was part of the business of the Company ; that the control of the Company was in England ; that the Directors in London exercised control over the Paris Office and that the Company was assessable under Case I of Schedule D of the Income Tax Act, 1918, in respect of the whole of its profits, including the profits of its Paris Office ;

(d) (1) That assuming (which was denied) that the said sum of £19,200 or any part thereof represented commutation, or compensation for loss of salary to which Mr. Haylor would have continued to be entitled had he remained a Director and which would have continued to be an admissible deduction year by year in arriving at the Company's profits for assessment, the said sum of £19,200 paid or payable as such commutation or compensation and each instalment thereof was a capital sum and was not an expense proper to be set against the receipts of the Company on revenue account for the purpose of computing the balance of its profits;

(2) That assuming (which was denied) that the said sum of £19,200 or any part thereof represented compensation for loss of salary, it was a voluntary payment, inasmuch as, in the circumstances the Company was entitled to dismiss Mr. Haylor without compensation of any kind and was not under any obligation to continue to retain him in its service and pay him a salary. This was not therefore a commutation of any yearly sum which the Company continued liable to pay ;

(3) That the agreement to pay the sum of £19,200 was a compromise of a claim for £50,000 and if any part of this sum represented compensation for loss of salary (which was denied) the payment represented not only compensation for such loss, but also generally compensation for loss of anticipated dividends as a shareholder and of surplus profits as a Note holder, neither of which matters could in any circumstances be the subject of deduction in arriving at the Company's profits for assessment. The agreement of 30th December, 1921, did not attempt to apportion the £19,200 as between compensation for loss of anticipated dividends and surplus profits on the one hand and loss of salary on the other hand, and there was no evidence upon which the Commissioners could find that any particular sum was in fact payable or paid as compensation for loss of salary or by way of commutation of any payment which had it continued to be made year by year would have been an admissible deduction in arriving at the Company's profits for assessment;

(4) That in essence the sum of £19,200 was domestic expenditure incurred for the purpose of buying out a Director and shareholder for purely personal reasons and was not expenditure incurred for the purpose of earning profits of the Company;

(5) That neither the said sum of £19,200 nor the said instalment of £5,200 nor any other instalment thereof was money wholly and exclusively laid out or expended for the purposes of the Company's business ;

(6) That neither the said sum of £19,200 nor the said instalment of £5,200 nor any other instalment thereof was admissible as a deduction in computing the profits of the Company for assessment to Income Tax.

(e) That the said assessments were correct and should be confirmed.

13. We, the Commissioners who heard the appeals, held—

(1) That we must concur in the decision given by our colleagues on 15th November, 1921, that the businesses in London and Paris were two separate businesses owned by the same person ;

(2) That the control of the Paris business remains in London, that the London Directors exercised control over the Paris office, and that the Company was assessable under Case I of Schedule D of the Income Tax Act, 1918, in respect of the Paris profits ;

(3) That the instalment of £5,200 paid to Mr. Haylor should be allowed as a business expense ; and as a result we reduced the assessment for 1923-24 to £6,254 ; we reduced the assessment for 1922-23 to £5,496 and we confirmed the assessment for 1921-22 in the sum of £3,411.

Immediately upon the determination of the appeal, the representative of the Company declared to us his dissatisfaction with our decision under head (2) of paragraph 13 above, and the representative of the Crown declared to us Ms dissatisfaction with our decisions under heads (1) and (3) of the same paragraph, as being erroneous in point of law and in due course required us to state a Case for the opinion of the High Court pursuant to the Income Tax Act, 1918, Section 149, which Case we have stated and do sign accordingly.

Mark Sturgis, H. M. Sanders,

Commissioners for the Special Purposes of the Income Tax Acts.

York House,

23, Kingsway,

London, W.C.2.

9th June, 1926.

Judgment on the Crown's Cross Apeal

14. Rowlatt, J.—In this case the question is whether there can be deducted in arriving at the profits of the Company, as an expense of carrying on the trade, an instalment paid in the year in question on account of the very large sum which was payable to this outgoing Director, Mr. Haylor, under the terms of the agreement.
15. It was said (and perhaps this is the clearest as well as the most authoritative statement on the point), in Atherton v. British Insulated and Helsby Gables, Limited, by the Lord Chancellor, on page 191 of Volume X of the Tax Cases, that

"a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade."

16. It is only made voluntarily, it may be, but it is under that sort of description, that this was said to be an expense incurred wholly and exclusively for the purposes of the trade.
17. The other point is whether it was capital expenditure.
18. This point as to the deductibility of a payment made upon the termination of a person's employment was glanced at in the House of Lords in Royal Insurance Company v. Watsoni^[16] Lord Herschell reserved his opinion upon it without expressing any view. Lord Shand said that he thought damages paid to a dismissed servant—and I suppose he would include a sum paid by way of agreement to get rid of the claim for damages—might be (and I think it was said with a good deal of force in the argument that that would be) a deductible expense. I think that in the ordinary case a payment to get rid of a servant, when it is not expedient to keep him in the interests of the trade, would be a deductible expense. I leave out of consideration for the moment special cases as when a servant is dismissed on the ground of a purely personal quarrel, although his staying would not affect the trade at all. I leave cases of that kind out of consideration for the moment. But it seems to me that a payment to get rid of a servant in the interests of the trade is a proper deduction. After all, a person who carries on a trade has to employ an efficient staff. He has to employ a staff that will prove satisfactory to the customers of the trade, and he has also to cease from employing an inefficient staff and a staff that does not get on with the customers of the trade; and if he has to pay for that cessation it seems to me that there is no reason why that should not be an expense incurred for the purposes of the trade. He has to facilitate people going when they reach the age of retirement, in their own interests and in the interests of then-employer. He has to hold that prospect out to them. If he has not held out the prospect, at least he has to deal with the situation and provide in some way, as Lord Cave says^[17], on the grounds of commercial expediency, for people who now have to leave his employment. Such was the case of the law reporter^[18]. I do not think that payments of that kind are like the loss in Strong and Company., Limited v. Woodifield^[19]. In that case it was a loss. Damages had been recovered for an accident which had happened in the house; but if, without the verdict of a jury, a payment had been made, I take it that would have been upon the same footing. It was near the line, I daresay, and Lord James of Hereford obviously thought so, but it was an expense collateral to the actual trade. But where the expense is connected with the keeping of an adequate staff, who earn the profits of the trade by their labours, it seems to me that that is not within the principle of Strong v. Woodifield(²).
19. So much for the general situation. I should not have much difficulty if this were a question of paying a month's wages or six months' wages in lieu of notice to an employee who, the employer had found, from the business point of view, could not possibly be retained because he was turning away custom. I should not have much difficulty about that. But here we have very special facts and very big figures, and the question is whether there is anything in these facts that makes a difference. What was the \ position? This Director had a substantial salary, and the normal measure would be the loss of his salary, subject to a discount on the ordinary principle, in consideration of the fact that he might be out of employment. But there was this peculiarity : If he was dismissed, then he had to sell his extraordinarily valuable shares—shares which paid 677 per cent. dividend—at par, and he also had to surrender some profit-sharing notes which he held, which were very valuable property. Therefore he was in a position to say :

"I am not going to be dismissed on a calculation of the salary I lose, because the measure of my damages must include the loss of the premium value of my shares and the loss of my profit-sharing certificates. "

20. Therefore the Company had to pay a much larger sum. They paid it because it was essential in their opinion, as the Case finds, to get rid of him for the sake of the good name of the Company and they did not want any litigation or publicity or any scandal or anything of that kind, so they paid it for business reasons. It seems to me that they paid all this sum—although the circumstances are very peculiar—simply to get rid of the Director. These other items came in, but they only came in as enhancing the measure of the claim which they had to deal with. It is true that in the agreement it is said that he agreed with the company to transfer the shares at their face value to his co-directors ; and that he undertook to surrender his profit-sharing certificates to the Company or as they should direct; but I think that is only putting into the agreement the obligation upon him, as he was being paid in respect of these heads of damage, that he would deal with them on the footing which formed the basis of his payment, namely, that he should part with these pieces of property. I do not think it can be said that there are two things in this payment : First of all, a compensation for the loss of his salary, and secondly, independently, a buying of the shares and a buying of his profit-sharing certificates. I do not think that is the view of it. I think the whole sum was a sum paid to him to induce him to go —to get rid of him, in other words. Therefore it seems to me that this was a business expense.
21. Now comes the question of whether it was a capital expense. I do not think the cases in which there was the question of a lump sum payment to avoid a recurring business expense have anything to do with this case. There is no question here of a recurring business expense or payment of a capital sum to get rid of it. I do not think that is the point of view from which one approaches this case. I do not think it is on that ground that the subject can successfully argue that this is not a capital expense. But is it a capital expense on any ground? As Lord Cave points out, again in the case of Atherton v. British Insulated and Helsby Gables, Limited^[20], it is a capital expense if you buy an asset or purchase an enduring advantage. This was not that case, or anything like it. What it is more like, perhaps, is the case of a payment made to remove the possibility of a recurring disadvantage. If a business is being carried on under circumstances' affecting (we will say) its property, as a business carried on under circumstances which concerned the silting of a channel, or on premises which involve continual trouble and expense, and a payment is made to put the premises on a different footing, that is a capital expenditure. There the persons carrying on the business say to themselves :

" Instead of having this silting channel, we will have a concrete channel, in which there will be no silting at all. If you say, I will not have a ' railing which perpetually falls down or wants repainting; ' I will abolish it and I will build a brick wall which will not fall '' down or will not want repainting , "

that is a capital expenditure. But I do not see how that can be said in this case. This gentleman being there as an unsatisfactory servant was not a permanency. He was no doubt there for his life, but I do not think you can say :

"By an expenditure of capital I will get rid of this nuisance affecting my business, and have his room rather than his company by making this capital expenditure."

22. I cannot look at it in that way. It seems to me it is simply this, although the largeness of the figures and the peculiar nature of the circumstances perplex one, that this is no more than a payment to get rid of a servant in the course of the business and in the year in which the trouble comes. I do not think it is a capital expense; and I have already held that it is an expense incurred in the conduct of the business. Therefore I am unable to differ from the Commissioners, and this appeal fails.

Mr. Konstam.—My appeal was dismissed with costs, and now my learned friend's appeal is?

Rowlatt, J.—Yes. This is the same case as the last one. We have done with Noble now?

Mr. Konstam.—Yes, my Lord, we have done with Noble now.

An appeal having been entered against the decision in the King's Bench Division in the second case, the case came before the Court of Appeal (Lord Hanworth, M.R., Sargant and Lawrence, L.JJ.) on the 7th February, 1927, when judgment was given unanimously against the Crown, with costs, confirming the decision of the Court below.

The Attorney-General (Sir Douglas Hogg, K.C.) and Mr. E. P. Hills appeared as Counsel for the Crown, and Mr. Konstam, K.C., Mr. Le Quesne, K.C., and Mr. Merlin for the Company.

Judgment.
23. Lord Hanworth, M.R.—This is a case which raises, first, a point discussed in a number of cases to which our attention has been rightly called, as to whether or not a deduction can be made within Rule 3 of the Rules applicable to Cases I and II of Schedule D of the Income Tax Act, 1918, that is to say, as being a sum wholly and exclusively laid out or expended for the purposes of the trade; secondly, the question whether, if it is so wholly and exclusively laid out, it is to be attributed to capital or to income.
24. Now I need not recount the whole of the facts which are set out in the Case. The Company was in its nature a private company and the business which was carried on was a business of insurance brokers and reinsurance brokers. It was a company which had business both in London and Paris, and the special circumstances of the holding of the capital and the original issue of the notes which are provided for under the agreement to which our attention has been called, offer features which are somewhat different from the usual, and peculiar to this present trading company. It was, however, a company which with a very small capital was able, by reason of the standing which it had acquired and the personal attributes of its directors, to do a large business which resulted in very large dividends upon the small capital with which it was carried on. In the year 1921 disputes arose with a particular director. That director was a shareholder and he was in a position, even if he had been removed from his directorship, still to hold his shares. The charge against him was that he had been guilty of conduct which would have brought him within a clause of the agreement of the 25th November, 1918. That clause provided that if a director should commit an act of bankruptcy or compound with his creditors or be guilty of such misconduct towards the Company or otherwise as would in the absence of any agreement to the contrary entitle a company to summarily dismiss a director so offending from his employment, the Company should have power to dismiss him forthwith, paying to him such a proportion of his salary only as should then be due. Then a provision, was made whereby that clause could be put in force; and, further, under clause 19, within one calendar month of either of these directors being dismissed from his employment under the provisions of clause 18 to which I have just referred, either or both of the remaining parties—that is the other directors— should be at liberty to give to the party so dismissed notice in writing requiring him within seven days to sell at par and transfer to the remaining parties, either in equal shares or such shares in proportion as they should in writing direct, the whole, of the shares in the Company then held by the party so dismissed. In 1920 disputes arose which were with this director who was the holder of a certain number of shares, and it was alleged against him by his colleagues that he had in fact been guilty of conduct which would have brought into operation that clause 18, with the consequent rights which would have inured to them of being able to demand that he should hand over the shares under clause 19. Now the Case finds this : Upon this situation having arisen

" the other directors desired to get rid of '' him and considered it necessary for the sake of the good name of the Company to do so. It was admitted in evidence before '' us that the Company might possibly have been justified by law in exercising its powers of dismissal, . . . but as the other directors were very anxious that the matter should not become public, and that a scandal affecting the reputation of Company should be avoided, they entered into negotiations with [this director] for his retirement, "

and ultimately terms were agreed. The effect of that agreement was shortly this, that with reference to his shares in respect of which a demand could have been made under clause 19, if he had been guilty under clause 18, those shares were transferred at face value to his colleagues, but this director was not minded to admit that he had been guilty of conduct which enabled his colleagues to put in force clause 18; he was, however, prepared to negotiate, and no doubt the fact was that he was in a strong position. Now this is a company which was doing very good business indeed; it is a business, however, to which good faith, standing and credit are essential, and we must by no means overlook the findings of the Commissioners that the other directors considered it necessary for the sake of the good name of the Company to get rid of this director, and they also were bona fide satisfied that if possible they ought to avoid a scandal affecting the reputation of the Company, for both those objects were objects which were of deep importance to the Company. The Company's immediate as well as future interests were concerned in the way in which the directors handled that situation. The directors had to deal with a difficult problem, and remembering their attitude which I have already recounted, it seemed right to them to make an agreement with this director which should prevent a scandal, free the Company from the serious position in which the continuance of this director as a director would have placed it, and enable the Company to continue to maintain its good name and its good business. By the agreement, therefore, which they made on December 30th, 1921, apart from the term whereby the other directors bought his shares, it was agreed that the Company should pay to this director a sum of £19,200 and this total was the agreed sum settled between the parties, but this payment was to be by instalments over a period of four years; there was to be an immediate payment of £5,200, and for the rest there were to be four payments of £3,500 successively year by year.

25. Now it is contended first that this sum of £19,200 is not money wholly and exclusively laid out or expended for the purposes of the trade within the meaning of Rule 3. The Commissioners, after they had found the facts to which I have referred, held that it was a business expense, and they allowed the deduction. I think that we must interpret that phrase of the Commissioners as meaning this, that the expense was incurred for the benefit of, and in relation to, the carrying on of the business of the Company; and after looking at their findings in clause 9, I can well understand their reaching that conclusion. Secondly, I think that the observation of my learned colleague is well founded : that in fact they did allow the deduction, with the result that what they intended to do was to show that in treating it as a business expense they meant to find, so far as it is a question of fact, that it was an expense wholly and exclusively laid out or expended for the purposes of the trade. Mr. Hills, however, is quite right in saying that the mere finding of fact would not be sufficient unless it was possible for an expense of this sort to have attributed to it the necessary characteristics which are required in order that in law it may be a deduction. By this Rule no deductions are to be made unless the requirement of Rule 3 (a), which I have already read, is fulfilled, and also no deduction can be made under Rule 3 (/) in respect of capital withdrawn from the trade.
26. Now upon the first point whether or not this was an expense wholly and exclusively laid out for the purposes of the trade, it appears to me that so far as the question of fact can be found, there is a definite finding of the Commissioners that it was so; and as to whether or not they could or were entitled to find that it was an expenditure for the purposes of the trade, I agree with Mr. Justice Rowlatt that the words used by Lord Cave the Lord Chancellor, in his speech in the case of the British Insulated and Helsby Cables, Limited v Atherton are germane to this decision. He says there^[21] :

" It was made clear in the <' necessity and with a view to a direct and immediate benefit to the trade but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of a business, may yet be expended wholly and exclusively for the purposes of the trade. "

27. If I may respectfully say so, I think the authorities which are cited by the Lord Chancellor clearly point to that being a compendious summary of the effect of them. When I look at those words and apply them to the facts of this case, it appears that once there was a finding that the co-directors were minded in doing what they did to save their trade from a scandal, that the directors were satisfied that it was not possible to keep, this director as a director but that it was m the interest of the good name of the Company to get rid of him, one must hold first of all that this is a sum expended by the Company- for it was in relation to the Company and his conduct towards the Company that clause 18 might have been applied and might have been contested. Further I think it is plain that within Rule 3 (a) this sum ought first of all to be allowed to be, deducted as an expense for the purposes of the trade. Applying another test an older test, which is laid down in Strong & Company, Limited v. Woodifield by Lord Loreburn on page 452 of 1906 Appeal Cases where he says^[22] :

" I think only such losses can be deducted as are connected with it in the sense that they are really incidental to the trade itself, "

28. I think the same results follow; or if I apply the words of Lord Davey on page 453^[23]

"These words are used in other Rules, and appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade."

29. It seems to me that the directors had to handle a situation of both delicacy and gravity, and their bona fides being questioned, it is clear that they took a course which they were justified in taking and made a payment in the interests of the carrying on of their trade. That being so, the second question arises : Is it to be treated as a capital expense? It is said, and not unfairly, that you have a sum definitely agreed, a payment no doubt by instalments, but for all practical purposes the sum is immediately ascertained and is in that sense in the nature of a capital payment, liquidated though it may be over period of time ; and it is said that for this payment they obtained an immediate result, namely, the resignation of the director, It was not a recurring incident; it was not something which would have to be dealt with in subsequent years, but it was an immediate result final in its conclusion inasmuch as it severed the connection between the director and the Company. Now all that is very true and I agree that perhaps it is more difficult to see whether it should be treated as a capital payment or not, but I think Mr. Justice Rowlatt puts it well at the end of his judgment where he says:

"This gentleman being there as an unsatisfactory servant was not a permanency. He was no doubt there for ' his life, but I do not think you can say: ' By an expenditure ' ' of capital I will get rid of this nuisance affecting my business, ' ' and have his room rather than his company by making this ' 'capital expenditure.' I cannot look at it in that way. It ' seems to me it is simply this, although the largeness of the ' figures and the peculiar nature of the circumstances perplex ' one, that this is no more than a payment to get rid of a servant ' in the course of the business and in the year in which the ' trouble comes."

30. We have had a number of cases reviewed again which were discussed and considered in this Court and in the House of Lords in the British Insulated and Helsby Cables, Limited v. Atherton^[24], and the Lord Chancellor gives instances of payments which although apparently final in their quality have been held to be properly chargeable against the receipts for the year.

"Instances, he says on page 213 ^[25], of such payments may be found in the gratuity of £1,500 paid to a reporter on his retirement(3) .... and in the expenditure of £4,494 in '' the purchase of an annuity for the benefit of an actuary who had retired, which in Hancock's case(⁴) was allowed, and I think rightly allowed, to be deducted from profits."

31. Now I respectfully share the view of Lord Buckmaster that it is not easy to find much help from the particular facts of decided cases; nor is it easy to define the limits of the principle upon which one is. acting. At the same time I think in a concrete case it is possible to determine whether an expenditure is a capital expenditure or rightly to be attributed to revenue. I do not in the least wish to go back upon anything that I said myself in the British Insulated and Helsby Cables case(1), but it appears to me upon the facts of this case that this payment should be treated as a revenue item and not as a capital item. It seems to attain more closely to Hancock's case^[26] and the Law Reporting case^[27] than to other cases such as Ounsworth v. Vickers^[28] and the Helsby Cables case^[29] itself. It is a payment made in the course of business, dealing with a particular difficulty which arose in the course of the year, and was made not in order to secure an actual asset to the Company but to enable them to continue, as they had in the past, to carry on the same type and high quality of business unfettered and unimperilled by the presence of one who, if the public had known about it, might have caused difficulty to their business and whom it was necessary to deal with and settle with at once.
32. For these reasons it appears to me that on the second point Mr. Justice Rowlatt was also right. I agree therefore with his reasoning and his conclusions, and I think the appeal must be dismissed with costs.
33. Sargant, L.J.—I am of the same opinion. So far as questions of fact go, the decision of the Commissioners is in favour of the taxpayer here; but, of course, the decision in a case of this kind is not conclusive, because it is obvious that questions of law, as well as of fact, arise in determining whether or not such a payment as this is brought within the permissible deductions allowed under the Income Tax Acts.
34. Now, first, as to the question whether this was a disbursement wholly and exclusively laid out or expended for the purposes of the trade, it seems to me that there is nothing at all to show that it was not so exclusively laid out. The object, as disclosed by paragraph 9 of the Case, was that of preserving the status and reputation of the Company, which the directors felt would be imperilled either by the other director remaining in the business or by a dismissal of him against his will, involving proceedings by way of action in which the good name of the Company might suffer. To avoid that and to preserve the status and dividend-earning power of the Company seems to me a purpose which is well within the ordinary purposes of the trade, profession or vocation of the Company. A good deal of stress was laid upon this, that the individual directors were enabled to purchase at par shares in respect of which a very large dividend was being earned, but it is to be noted that that is only precisely what they would have been entitled to do if the director had been in fact dismissed under clause 18 ; they would have been entitled to get his shares under clause 19. Beyond that, it appears to me that in a company of this kind it was absolutely necessary that if a director did leave the service of the Company, his shares should be transferred to the remaining directors of the Company. The constitution of the Company, which was substantially a private company, showed that it was recognised that the very small share capital— very small in proportion to the earning power of the Company— should be held, and held exclusively by those who had the direction and management of the Company. Again, the mere fact that this very large dividend would be earned for the directors on the shares so transferred does not appear to me in any way conclusive or tending against them, for this reason, that they, if they were to get these dividends, got those results through the prosperity of the whole company. It was only as an incidental or secondary result of the prosperity of the whole company that their shares, and the participating certificates, would result in large profits for them, and therefore, although that might be the result, none the less, as it was a secondary result and only followed upon the prosperity of the whole company, a payment to ensure the prosperity of the whole company was not, in my judgment, in any way tarnished or rendered suspicious by the fact that it would ultimately inure in a secondary sense for the benefit of those who remained the directors and managers of the Company. Then comes the next point: whether this very large payment was a payment which was so exceptional in its nature that it must be considered as a capital payment and not a payment by way of deduction from annual outgoings. With regard to that, I entirely agree with the view of the learned Judge, that the dismissal of a servant, or compensation paid to ensure the dismissal of a servant (which, of course, this director was—a servant of the Company) is a payment which would in the ordinary course be attributed to the year in which the payment was made, and I see no reason for thinking in this case that it was of the nature of a capital expenditure. A situation of this sort is, unfortunately, liable to recur; I hope it may not recur in the annals of this Company; but by making the payment they have in no way ensured that it shall not occur in the future, any more than in the case of any other company. I am a little struck with this, a circumstance which I think was noted in the dissenting judgments both of Lord Carson and Lord Blanesburgh in the case to which so much reference has been made^[30], that it is impossible to say to what capital account of the Company you could possibly attribute this payment. It is quite impossible to put against the capital account of the Company, as I conceive it, a payment of this nature. It seems to me that the payment, though large and though exceptional, was not of such a nature; it certainly was not capital withdrawn from the Company, or any sum employed or intended to be employed as capital in the business. It was a payment which as a matter of fact was made out of the profits of the Company, apparently, as to the £5,200, in the year in which it was paid, and, as to the future payments, they will have to be made from the profits of the years in which those payments will have to be made. To my mind, it is essentially different from those various payments in the cases which have been referred to, which were of the nature of adding to, or improving the equipment, or otherwise made for the permanent benefit of the company.
35. Mr. Hills spoke throughout of the directorship of the director who was dismissed as being for life, but I think that really is to miss the point. He was to be a director for life unless he was dismissed; and it was because the other directors thought he was liable to be dismissed and were seeking to dismiss him, and therefore to make his office a much more temporary office than an office for life, that the whole of this question arose and that this payment had to be made.
36. In my judgment, the learned Judge was right on both points, and the appeal should be dismissed.
37. Lawrence, L.J.—I agree that the sum in question was wholly and exclusively expended by the Company for the purpose of its business, in the sense that the sole object with which the Company made the payment was to enable the Company to continue to carry on and earn profits in its business.
38. On the question whether the sum is a capital or revenue expenditure, a point upon which the Commissioners have given no express finding, I confess to having entertained doubts, which are not yet wholly resolved. I am not fully convinced that the payment was not made to secure '' an advantage for the enduring '' benefit of a trade '' within the meaning of that expression used by Lord Cave in the British Insulated and Helsby Cables case^[31]. As, however, both the Master of the Rolls and Lord Justice Sargant have arrived at a definite conclusion that the sum was a revenue expenditure, and as my doubts are not strong enough to cause me to dissent from the judgments just delivered, I do not think that any useful purpose would have been served if Counsel for the Respondents had been called upon. Accordingly, the appeal will be dismissed.

Lord Hanworth, M.R.—Dismissed with costs.

Note 1   Omitted from the present print, with the exception of Article No. 15.     [Back]

Note 2   Omitted from the present print.    [Back]

Note 3   Omitted from the present print    [Back]

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Note 14   Omitted from the present print    [Back]

Note 15    Omitted from the present print    [Back]

Note 16   3 TC 500    [Back]

Note 17   Atherton v. British Insulated and Helsby Cables, Ltd., 10 T.C. at p. 191    [Back]

Note 18   Smith v. The Incorporated Council of Law Reporting, 6 T.C. 477.    [Back]

Note 19   5 TC 215.    [Back]

Note 20   10 T.C. at p. 192.    [Back]

Note 21   10 T.C. at p. 191    [Back]

Note 22   5 T.C. at p. 219    [Back]

Note 23    Ibid. at p. 220.    [Back]

Note 24   10 TC 155    [Back]

Note 25   Ibid, at p. 192.    [Back]

Note 26   Hancock v. General Reversionary and Investment Company, Ltd.,. 7 T.C. 358    [Back]

Note 27   Smith v. The Incorporated Council of Law Reporting, 6 T.C. 477.    [Back]

Note 28   6 T.C. 671    [Back]

Note 29   10 TC 155    [Back]

Note 30   Atherton v. British Insulated and Helsby Cables, Ltd., 10 TC 155.    [Back]

Note 31   10 TC 155 , at p. 192.    [Back]