Scottish Court of Session Decisions

On an appeal by the Leith, Hull, and Hamburg Steam Packet Company, shipowners, Leith, against the decision of the General Commissioners of Income-Tax, the following case was stated by the latter for the opinion and judgment of the Court of Exchequer under the Taxes Management Act 1880 (43 and 44 Vict. cap. 19), sec. 59:—“At an adjourned meeting of the Commissioners for General Purposes under the Property and Income-Tax Acts, for the county of Edinburgh, held at Edinburgh on the 15th day of February 1898, for the purpose of hearing and disposing of appeals, The Leith, Hull, and Hamburg Steam Packet Company appealed against the assessment imposed on them for the year ended 5th April 1897 under Schedule D of the Property and Income-Tax Acts, and craved a reduction of the assessment to the extent of £7765, on ‘the ground of overcharge, consequent upon insufficient allowance for wear and tear.’

The appellants having requested that the profits of their business should not be made public, the Surveyor of Taxes, Mr Philip Musgrave, on behalf of the Crown, agreed that the annual profits should not appear in the case.

The following are the facts found or admitted:—(1) The appellants are the owners of a fleet of thirty-seven iron and steel steamers, which they employ in trading between Leith and Newcastle, Sunderland, Hull, Hamburg, and the Baltic ports. The ages of the steamers vary from one to thirty-seven years. (2) The Crown and the appellants agreed upon a sum to be taken as representing the profit earned by the appellants from their business as shipowners, estimated in terms of the first rule of the first case of Schedule D of section 100 of the Income-Tax Act 1842, on an average of the three years ended the 31st day of December 1895, and that they are assessable to income-tax for the year ended 5th April 1897 on said sum, less the just and reasonable deduction to represent the diminished value of their vessels by reason of wear and tear during the year, as authorised by section 12 of the Customs and Inland Revenue Act 1878. (3) In addition to the allowance for diminished value by reason of wear and tear, the appellants, in bringing out their gross profits, are entitled to deduct and do deduct the cost of all repairs and of all replacements of parts of their vessels requiring replacement, except new engines and boilers, the cost of which (following a general practice among shipowners) is charged to capital, and thus becomes subject to allowance for wear and tear. (4) To facilitate the adjustment of the allowance for wear and tear, the Crown and the appellants agreed that one-half in value of the fleet were passenger steamers, and one-half cargo steamers; and it was also agreed that passenger steamers diminish more rapidly in value from wear and tear than cargo steamers, and that in arriving at the allowance for wear and tear, 1 per cent. might be taken as representing the difference to be allowed between the one and the other. (5) Shipping may diminish in value from various causes, but it is admitted that physical deterioration on account of wear and tear is the only cause of diminished value that comes within the provisions of the Customs and Inland Revenue Act 1878. (6) For the year ended 5th April 1897 the appellants claimed for depreciation by reason of wear and tear £30,534, but the assessing authorities reduced the allowance to £22,769, which is equal to 5 1 2 per cent. on £413,984, the written-down value of the appellants' steamers at 31st December 1895. The deduction allowed by the assessing authorities is at the rate of 6 per cent. on the written-down value of passenger steamers, and 5 per cent. on the written-down value of cargo steamers; and as it is agreed that one-half in value of the appellants' fleet consists of passenger steamers and one-half of cargo steamers, 5 1 2 per cent. (the mean between 5 and 6 per cent.) on the diminishing value of the steamers has been allowed as a deduction on the written-down value of the whole fleet.

We, the Commissioners, after hearing

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parties, refused the appeal, and confirmed the assessment. Whereupon the appellants expressed dissatisfaction with our decision as being erroneous in point of law, and required that a case should be stated for the opinion of the Court of Exchequer, and it is hereby stated and signed accordingly.

The opinion of Sheriff Rutherford, who delivered the decision of the Court, and a statement showing the effect of depreciation on the diminishing value of a steamer costing originally £20,000 at various rates per cent., and on which the decision proceeded, are subjoined as an appendix to this case.

The question of law for the opinion of the Court is—Whether the deduction of 5 1 2 per cent. for wear and tear allowed by the Commissioners is or is not just and reasonable, and a fair and valid exercise by the Commissioners of the discretionary power conferred upon them by the 12th section of the Act 41 Vict. cap. 15?— And. Rutherfurd; Geo. Auldjo Jamieson; Alex. W. Inglis.

Edinburgh, 10th November 1898.”

The opinion of Sheriff Rutherfurd appended to the stated case was in the following terms:—“The income tax is a tax upon gross profits subject to certain deductions specially authorised by statute, and prior to the year 1878, in assessing the duty payable under Schedule D of the Act 5 and 6 Vict. cap. 35, no deduction was allowed on account of the annual depreciation in value by wear and tear of machinery or plant used in producing the profits.

This appeared to the Legislature to be a hardship to the taxpayer, and accordingly it was provided by the Customs and Inland Revenue Act of 1878 (41 Vict. cap. 15), section 12, that ‘notwithstanding any provision to the contrary contained in any Act relating to income-tax, the Commissioners for General or Special Purposes shall, in assessing the profits or gains of any trade, manufacture, adventure, or concern in the nature of trade chargeable under Schedule D, or the profits of any concern chargeable by reference to the rules of that schedule, allow such deduction as they may think just and reasonable, as representing the diminished value by reason of wear and tear during the year of any machinery or plant used for the purposes of the concern, and belonging to the person or company by whom the concern is carried on.’

It seems to me that the purpose of this enactment plainly was to allow the taxpayer such a deduction from the amount of profits annually realised as will fairly and reasonably represent the diminished value by wear and tear during the year of the plant used to produce these profits, so that when his plant is worn out he may be in a position to replace it by new plant or machinery of a like description. I observe that the statute does not require the Commissioners to ascertain the actual depreciation in value of machinery or plant during the year, but to allow such deduction therefor ‘as they may think just and reasonable,’ It would obviously involve in most cases a very expensive and laborious inquiry if the taxpayer, in order to get the benefit of the allowance for wear and tear, had to show the annual diminution in value from this source of each item of his plant. In the course of the discussion I suggested by way of illustration the case of a railway company owning hundreds of steam engines and thousands of carriages, waggons, &c., and I think that the same thing holds good in the case of large manufacturers and owners of shipping. If in the present instance it were necessary to ascertain the actual depreciation in value of each of the appellants' ships by reason of wear and tear exclusively, we have not been furnished with details sufficient for that purpose. But in my opinion that is not necessary, and I think that the appellants will have no reason to complain if we can otherwise fix such a rate of deduction from their profits (and of course if there are no profits there will be no assessable income), which will enable them to replace their vessels, when these are worn out by wear and tear, with others of the same original value.

Now, in order to determine such a rate of deduction from profits realised by the shipowner, it is hardly necessary to say that we must in the first place ascertain, as nearly as possible, the period within which a steamship (for it is only with steamships that we are here concerned) would become unproductive of profit by reason of ordinary wear and tear, without taking into account loss by shipwreck, or depreciation in value through the introduction of vessels of an improved type, or other similar causes.

In an appeal last year at the instance of the Leith, Hull, and Hamburg Steam Packet Company, the Commissioners came to the conclusion that the average duration of the life of steamships, including vessels built either of iron or steel, and designed either for cargo or for passenger traffic, might fairly be computed at about twenty-two years, having regard merely to their annual diminution in value by reason of wear and tear. In the present instance Mr Warrack during the discussion frankly stated, in answer to a question which I put to him, that he did not, on behalf of himself and the other shipowners who concurred in his views, object to the period of twenty-two years being held to be the average life of steamships as affected solely by wear and tear. On the part of Messrs James Currie & Company, who represent the Leith, Hull, and Hamburg Steam Packet Company, and who maintain that their case is exceptional, it was stated that they are the owners of thirty-seven sea-going steamers, of which thirty-five were built to their own order, viz., three iron and sixteen steel cargo ships, nine iron and seven steel passenger ships; and that from correspondence with some of the best known brokers for the sale of steamers, they deduce the following estimates of the probable average life of steamers of these classes as terminated by wearing out:—Iron cargo, twenty-six years, iron passenger, twenty-four years; steel cargo, twenty-two years, and steel passenger, nineteen years,—which gives an average of slightly over twenty-two years

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for the thirty-five vessels built to their own order.

In these circumstances I am of opinion that, for the purposes of the present inquiry, twenty-two years may fairly be taken to represent the average duration of the life of a steamship. On this assumption Messrs Warrack & Company and the majority of the appellants contend that the annual diminution in the value of their ships from wear and tear may be moderately estimated by a deduction from their profits of 7 per cent. in the case of cargo ships, and 8 per cent. in the case of passenger ships (which wear out rather more quickly), or 7 1 2 per cent. over all; while Messrs Currie & Company claim as a reasonable allowance 9 per cent. for cargo steamers, and 10 per cent. for passenger boats, or 9 1 2 per cent. over head. On the other hand, the officers of Inland Revenue maintain that 5 per cent. for cargo and 6 per cent. for passenger ships, or 5 1 2 per cent. over all, is a fair and sufficient deduction. In order to test this, the case has been put of a cargo ship costing originally £20,000, and in ascertaining what deduction from his profits an owner who is his own insurer would require to set aside in each year of her assumed life of twenty-two years, in order at the expiry of that period to indemnify himself for her annual depreciation in value by wear and tear alone, exclusive of loss by shipwreck and by other causes which cannot be taken into account, it is apparent that if he allowed 5 per cent., or £1000, on her original value in the first year, and at the same rate, or £950, on her diminished value for the second year, and so on, he would at the end of the twenty-two years have laid by sums amounting to £13,529, 6s. 7d.

It is not to be supposed, however, that a prudent man who is his own insurer would allow these sums to remain unproductive, and I do not think it is unreasonable to assume that they might be invested in his business, or otherwise, so as to yield 3 per cent. interest. At that rate the interest at the expiry of the twenty-second year would amount to £6975, which, added to the sums before mentioned amounting to £13,529, 6s. 7d., would leave the shipowner with £20,504, 6s. 7d. to recoup himself for loss by wear and tear of a vessel the original cost of which was £20,000.

But the appellants object to this mode of calculating the allowance to which they are entitled on the ground that, ‘of the £20,000 first cost, said to be repaid, all that the shipowners really get is £13,532, the remaining £6468 being wrongfully withheld by the Revenue authorities in name of compound interest claimed as due to them.’

It seems to me that this objection has arisen out of some misapprehension and confusion of ideas, for the Inland Revenue officers do not seek to withhold any portion of the deduction of 5 per cent. which they concede may be reasonably allowed for annual diminution of value by reason of wear and tear, and the case put is merely one illustration, with the view of showing that 5 per cent. on the diminishing value during each of the twenty-two years is a fair allowance; but the same result may be reached in a different manner, as, for instance, by taking the cost of a policy of insurance against the depreciation of a ship's original value by wear and tear during the period mentioned, and other tests have been suggested, to which I do not think it necessary to refer.

No doubt Messrs Warrack & Company and the majority of the appellants stated that, as the result of their experience, extending over a long period, they consider 7 1 2 per cent. to be a very moderate deduction for wear and tear, while Messrs Currie & Company say that they have come to the conclusion that in their case it should, at the very least, be 9 1 2 per cent.

Now, I must say that I am somewhat at a loss to see how there can be such a difference in circumstances, whether as regards the kind of ships or the traffic in which they are employed, as to warrant in the case of Messrs Currie & Company an allowance of 2 per cent. more than the deduction claimed by the other appellants. But however that may be, and while I am satisfied that the appellants, gentlemen whose opinions in matters relating to shipping are entitled to much weight, have given us what they believe in bona fide to be the actual results of their experience, I can only repeat that we have not before us the means of checking these results, and I cannot help thinking that further inquiry would show that the percentage which the appellants claim to have allowed them must include something more than depreciation merely by wear and tear.

Accordingly, I should be prepared to hold that 5 1 2 per cent. overhead is a just and reasonable deduction, irrespective of the decision of last year in the case of the Leith, Hull, and Hamburg Steam Packet Company, in which the Commissioners arrived at the same conclusion, and their decision was affirmed by the Court of Exchequer on appeal. But while the judgment in that case related to the assessment for a different year, and may not be res judicata, even as in a question with Messrs Currie & Company, it is certainly a precedent which I should consider myself bound to follow, unless some much stronger reasons for not doing so were submitted to us than any which we have yet heard.

On the whole matter, therefore, I am for dismissing these appeals.”

Argued for appellant—The real question before the Court was whether in calculating the amount to be allowed for depreciation the Inland Revenue were entitled to take into account that the sum annually allowed for depreciation might be invested by the appellants and interest derived from it. That this was the true question plainly appeared from the appendix to the stated case, and if the appendix were held not to be part of the case the Commissioners should be asked to amend the case so as to show in the case itself what was the real point in dispute. Depreciation was the sum which would represent the original cost of the vessel at the close of the period which constituted its life, and they were

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entitled to accumulate the sum allowed year by year in name of depreciation without investing it. The Commissioners had no right to take into account interest for the sum set apart for depreciation. There was no warrant for doing so in the statute; all that could be taken account of was the “diminished value by reason of wear and tear.” There was no discretionary power conferred on the Commissioners, the statute laid down a rule for estimating the deduction for wear and tear. If the Commissioners failed to apply this rule they committed an error in law, and they had done so in the present case.

Argued for the respondents—The case must be taken as it stood. It disclosed no question of law but a question of fact, viz., What deduction did the Commissioners think just and reasonable as representing the diminished value by reason of wear and tear? That was a question of amount, and therefore matter of fact and for the Commissioners to decide, and the Court should not send back the case to be amended but should refuse the appeal— Leith, Hull, and Humburg Steam Packet Company v. Bain, June 16, 1897, 3 Tax Cases 560; P. & O. Steam Navigation Company v. Lee, 1898, 79 L.T. 118. In any event on all questions of this kind a very wide discretion was vested in the Commissioners by the statute, and where the Commissioners had applied their minds to the point and decided it to their satisfaction the Court should not interfere with their decision— Caledonian Railway Company v. Special Commissioners of Income Tax, November 18, 1880, 8 R. 89; Burnley Steamship Company Limited v. Surveyor of Taxes, July 10, 1894, 21 R. 965.

At advising (January 27, 1899)—