Scottish Court of Session Decisions

The Income Tax Act 1842 (5 and 6 Vict. cap. 35), section 100, Schedule (D), First Case, Third Rule, enacts—“In estimating the balance of profits and gains chargeable under Schedule (D) or for the purpose of assessing the duty thereon, no sum shall be set against or deducted from … such profits or gains … for any sum employed or intended to be employed as capital in such trade … nor for any sum recoverable under an insurance or contract of indemnity.”

At a meeting of the Commissioners for the General Purposes of the Income Tax Acts, held at Glasgow on 30th October 1905, the Western Steamship Company, Limited, appealed against an assessment for the year ending 5th April 1905 made upon it under Schedule (D) of the Income Tax Acts, and claimed repayment of £41, 2s. as duty overpaid.

The Commissioners sustained the appeal and the Surveyor took a case for appeal.

The company had owned two steamships one of which, the “Kenmore,” bought by the company in the year 1898, was wrecked on 11th January 1904 and became a total loss. Its market value immediately before being wrecked was £37,000, and it was insured with underwriters to the amount of £34,500 on a valuation in the policies of £37,000. The company, in accordance with a common practice of shipowners, took upon itself a risk of loss to the amount of £2500, and claimed that to that extent it insured itself and ran a risk of loss on trading account. The amount actually paid by the company to underwriters for insurance premiums was allowed as a deduction from the profits of each year in arriving at the amount of the assessable profits of the year. The company, in accordance with its practice, transferred from its revenue account to its insurance fund a sum equivalent to the amount of premium that would have been payable to an underwriter on a risk of £2500, the amount of the risk undertaken by the company itself. No deduction from profits in calculating income tax was allowed for the sum so transferred. The company recovered from the outside underwriters the full amount of £34,500. In arriving at the amount of the assessable profits for the year ending 31st December 1904 the company claimed to deduct from its revenue for that year the sum of £2465, 4s. 1d., being the amount of the risk of £2500 undertaken by itself, less £34, 15s. 11d. received from the Salvage Association as the proportion of the proceeds of the sale of the wrecked “Kenmore” effeiring to the risk of £2500. The company transferred the said sum of £2465, 4s. 1d. from its insurance fund to its capital account.

The company contended—“(1) That the sum of £2465, 4s. 1d. transferred from its insurance fund was, especially looking to practice of shipowners and that followed by itself, a loss in trading and a proper deduction to be allowed from revenue in a question of income tax. (2) That as in making the assessment for the year 1904 and previous years the sums transferred from revenue to the insurance fund had paid income tax and had not been allowed as a deduction from revenue, a deduction in respect of the actual loss which had arisen could not be consistently refused. And (3) that it should not be put in a worse position than an outside underwriter, as, had the company insured the risk of £2500 with an outside underwriter, he would have been allowed the loss when it arose as a deduction from any profits.”

The Surveyor of Taxes maintained—“(1) That there was no authority in the Income Tax Acts for allowing the deduction of £2465, 4s. 1d. claimed by the company (5 and 6 Vict. c. 35, s. 159). (2) That said sum of £2465, 4s. 1d. was not a disbursement or expense incurred by the company in earning its profits, but was a sum transferred from its revenue account, and employed or intended to be employed as capital, and was not a proper deduction from profits (5 and 6 Vict. c. 35, s. 100, First Case, Rule 3 and Rule 1 applying to both First and Second Cases). (3) That any sum recoverable under an insurance or contract of indemnity is not deductible from profits (5 and 6 Vict. c. 35, s. 100, First Case, Rule 3).

Argued for appellant — The deduction claimed should not have been allowed, for the sum in question was capital. No deduction was allowed in respect of sums “employed as capital”—Income Tax Act 1842, Schedule D, First Case, Rule 3; Dowell's Income Tax Laws (5th ed.), pp. 133,145. Taking another view, the sum claimed to be deducted was part of the value of the ship which had been lost, i.e., part of the company's capital, and no deduction was allowed for “diminution of capital”—Income Tax Act 1842, sec. 159 (Dowell, p. 217); Inland Revenue v. Watt, February 20, 1886, 23 S.L.R. 403, 2 Tax Cas. 143; Smith v. Westinghouse Brake Company (1888), 2 Tax Cas. 357; Granite Supply Association, Limited v. Inland Revenue, November 7, 1905, 8 F. 55, 43 S.L.R. 65, Dowell, p. 148; Alianza Company, Limited v. Bell, [1906] AC 18. Further, no loss had in fact been suffered, for the vessel was fully insured, and deduction was not allowed for sums recovered under an insurance—Income Tax Act 1842, section 100, First Case, Rule Third, end ( v. Dowell, p. 145.)

Argued for respondents—Insurance was an outlay necessary to earn profit, and was therefore deductible— Inland Revenue v. Stewarts & Lloyds, Limited, July 20, 1906, 8 F. 1129, 43 S.L.R. 811. Income tax had been paid on the sums set aside in name of premiums, and therefore the principal sums corresponding thereto had been, as it were, enfranchised. Had these premiums been paid to underwriters instead of being transferred to the company's reserve fund, no tax would have been payable. The shipowners having constituted themselves their own insurers, ought not to be put in a worse position than if they had insured with outsiders. The deduction claimed was not loss of capital in the sense of the Act;

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it was merely a loss of accumulations of income which the company had set aside, and in respect of the loss of which deduction fell to be made.