Scottish Court of Session Decisions

The Customs and Inland Revenue Act 1888 enacts—section 24 (3)—“Upon payment of any interest of money or annuities charged with income tax under Schedule D, and not payable, or not wholly payable, out of profits or gains brought into charge to such tax, the person by or through whom such interest or annuities shall be paid shall deduct thereout the rate of income tax in force at the time of such payment, and shall forthwith render an account to the Commissioners of Inland Revenue of the amount so deducted, or of the amount deducted out of so much of the interest or annuities as is not paid out of profits or gains brought into charge as the case

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may be, and such amount shall be a debt from such person to Her Majesty, and recoverable as such accordingly.…”

The Lord Advocate, for and on behalf of the Commissioners of Inland Revenue, raised an action against the Edinburgh Life Assurance Company, incorporated by Act of Parliament, in which he sought to have the defenders decerned and ordained “to render to the Commissioners of Inland Revenue a full account of the sums deducted by the defenders in respect of income tax during the period from 5th April 1905 to 30th November 1907, upon their making payment of annuities charged with income tax under Schedule D; and whether such account be rendered or not,” to have them decerned and ordained “to pay to the pursuer the sum of £5809, 3s. 7d sterling, or such other sum, more or less, as may be found to be due and payable by the defenders in respect of income tax deducted by them as aforesaid.…”

The defenders pleaded, inter alia—“The defenders are entitled to absolvitor in respect that said annuities have in fact been paid out of profits and gains already brought into charge.”

The facts are given in the opinion ( infra) of the Lord Ordinary ( Johnston), and are summarised in the opinion of the Lord President.

On 30th July 1908 the Lord Ordinary, after a proof, assoilzied the defenders from the conclusions of the summons, and decerned.

Opinion.—The purpose of this action is to test the question whether life insurance companies which deal in annuities, and which, in the exercise of an option competent to the Inland Revenue, are assessed to income tax, not on their profits, but on their income from investments, are accountable to the Inland Revenue for income tax deducted from annuities paid to their annuitants, and if so, to what extent and effect?

The Edinburgh Life Assurance Company have been selected by the Inland Revenue as defenders with whom to test this question. It is said that during the period from 5th April 1905 to 30th November 1907, or a little more than two and a-half years, the company have paid in annuities chargeable with income tax under Schedule D, a sum of £116,259, 13s., and have in so paying deducted the sum of £5809, 3s. 7d. as income tax payable to the Crown thereon, but that they have not accounted for or paid to the Crown the sum so deducted. There is no dispute about this fact or about the figures. The Crown, founding upon the Customs and Inland Revenue Act 1888, section 24 (3) maintain that, having deducted the income tax in question, as they were bound to do, the company must account to the Commissioners of Inland Revenue for the same. The company maintain that the Crown's demand is an attempt to compel them to pay the same income tax twice over, and that the annuities in question having in fact been paid out of profits and gains already brought into charge, they are entitled to be assoilzied.

On the main contention I think that the defenders are right, though whether their argument is a complete defence to the Crown's claim remains for consideration. My short ground of judgment is that the Crown's claim is only made possible by their reversing their election to treat the defenders as assessable, not on profits, but on their income from invested funds. If they find the latter course more profitable, they are entitled to take it. But if they do, they must deal with the defenders consistently on that footing, and cannot be allowed to try and make the best of both worlds by assessing the defenders on one basis and calling on them to account for this particular item on another.

But as the case is avowedly a test case and of importance to the Revenue, and to most, if not all, life insurance companies, it is right that I explain the grounds which have brought me to this conclusion.

The Edinburgh Life Assurance Company was founded in 1823 under a contract of copartnery, which has since been but slightly altered by statute. One of its purposes was the granting and purchasing annuities, either for ‘lives or otherwise, and on survivorships.’

By head 28 the liability of the partners in the company, it having been founded without a charter, and before the Companies Act of 1862, was limited by this device. It was declared ‘that nothing herein contained shall extend, or be construed to extend, the liability of each proprietor beyond the amount of the share or shares which they respectively hold in the company, and that in every policy of insurance or other obligation entered into by the court of directors for behoof of the company, there shall be a special clause inserted declaring that the capital stock and funds of the company for the time being shall be the only fund answerable for any demand under such policy of insurance or other obligation; and that in no respect shall any member of the company be subject or liable for more than the amount of his or her share or shares of the capital stock thereof.’

In strict accordance with this provision, the form of bond of annuity adopted by the company, and still, I understand, in use, bears—‘Provided likewise that the funds of the company and the capital stock so far as not paid up at the time shall alone be answerable for any claim or demand under or by virtue of this bond; and that the partners of the company for the time being shall be subject and liable to such demand or claim, each to the amount then unpaid of his or her share of the said capital stock, but not to any further or greater extent, and that no other person or funds shall under any circumstances be liable or subject to any claim or demand under this bond.’

The only other points which call for note in the company's constitution are that articles 31 and 32 provide for a separation,

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which is still maintained, and is an essential of the contracts between the company and its insured, between the capital, ‘the Proprietors' Fund,’ and ‘the Assurance and Annuity Fund.’

The paid-up capital is, I understand, now £20 per £100 share on 5000 shares.

The Proprietors' Fund consists of ‘all other sums appropriated or to be appropriated to the proprietors by way of profit, and the interest, dividends, and accumulations of the same and of the paid-up capital’; and of these sums a separate account is to be kept, ‘apart from the other funds of the company, and which shall be called “The Proprietors' Fund.”’

On the other hand, ‘the amount of all premiums and other sums to be received for assurances, endowments, annuities, and other obligations undertaken by the company, and the interest, dividends, and accumulations thereof respectively,’ are to form ‘a separate fund, to be called “The Assurance and Annuity Fund,”’ and this fund is, in the first instance, to be ‘the fund for answering all claims and demands on the company in respect of its assurances or otherwise, and for defraying the expense of carrying on the business of the company.’

Article 34 provides for a quinquennial investigation and the ascertainment of the profit of the quinquennium by valuing the current obligations of the company and ‘deducting the net value of the liabilities from the assurance and annuity fund, and bringing into account any sums already paid out of current profits in respect of intermediate bonus,’ and the balance of profit so ascertained is to be divided in the following proportions, viz., one-tenth part thereof shall be added to the Proprietors' Fund, and nine-tenths parts thereof shall—after deducting the sums paid for intermediate bonuses as aforesaid—go to provide bonus additions to the sums in the policies then current.’

By article 38 the directors have power to lay out and invest ‘the funds of the company’ in any description of securities authorised or approved by the proprietors.

A proof was led, for the satisfaction of the Inland Revenue authorities, regarding the company's mode of dealing with their funds and keeping their accounts. But I do not think that anything was elicited which is not disclosed in the published revenue accounts and balance-sheets of the company, made up in the form prescribed by the Life Assurance Companies Act 1870.

The facts essential to the disposal of the present question are these, and they are very simple. The company does nothing but a life business. Annuities, as well as assurances on lives, are charged indiscriminately upon the whole funds of the company. No particular funds are set aside or investments ear-marked and charged with the annuity obligations of the company. Certain accounts kept in the books of the company prior to 1906, tending to show the contrary, may be disregarded. They were book-keeping entries having no real meaning, and have rightly been discontinued. The statutory annual accounts published by the company for the years 1905–6–7, which embrace the period in question, are Nos. 28, 29, and 30 of process, the last of them showing the result of a quinquennial investigation as at 31st December 1907. The states Nos. 37 and 38 of process show the result of that investigation from two points of view'. No. 37 of process shows that in the five years under review the interest and other income of the company from invested funds was £804,731. If the company's profits were struck after taking into account this item of income, the result of the five years' working of the company as a trading concern would show a net surplus of profit of £334,450. If, then, the company were to have been assessed on the profits of their business, they would in the course of five years have paid income tax upon the sum of £334,450 plus the amount of income tax actually deducted from their investment income, which would have been their net profits or gains for the year, instead of upon the sum of £804,731 plus the tax so deducted, on which they were actually assessed. No. 38 of process, again, shows that if the income from investments is excluded from the trading account, the result of the company's trading would be a substantial deficit on the five years of £195,681, if annuities paid, &c., are omitted from the account, or of £470,281, if, as I think, for proper comparison, they must be, those items are taken into account. It is clear, therefore, that but for the amount of income from funds set aside on actuarial calculations, and accumulated and invested to secure the company's obligations to its policy-holders and annuitants, and which income is already taxed as income from investments, the company would have no profits or gains to return for assessment. What is true over the quinquennium is true for any particular year, there being, of course, slight fluctuations in the respective figures of the different items from year to year. The income from investments is mostly taxed at the source. A comparatively small and fluctuating amount is assessed direct, and another similar amount escapes taxation by accruing abroad, and being left there for investment instead of being brought home. The amount of the annuities paid during the quinquennium was £218,463, or an average of about £45,000 per annum.

These are, I think, all the important facts which the accounts disclose, and the essential ones are that the company's annuities are charged indiscriminately with its other obligations on its whole funds; that but for the income from investment of accumulated funds, as a trading concern the company would not show any profit or gain; and that as its income from investments is already taxed as such income, it cannot again be taxed as profits or gains without double taxation of the same income resulting.

The determination of the question raised in this case depends on the interpretation and application of the enactment contained in the Customs and Inland

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Revenue Act 1888, sec. 24 (3). But it was pointed out by all the Lords who pronounced reasoned judgments in the case of London County Council v. Attorney-General, L.R. (1901) AC 26, that this section was not a charging section but an amending section, and could not be interpreted without considering how matters stood under prior legislation.

In 1803 the principle, which has been followed and extended in application ever since, of taxing income at the source where possible, was first adopted. The right of making deductions from gross income was abolished. Gross income was thereafter assessed, leaving to the person assessed to deduct and retain from the recipient of any payment charged on that gross income the tax corresponding to such payment.

When the schedules included in the Income Tax Act 1842 were adjusted, for some reason annuities and annual interest on money were not included in any of the schedules, but were made the subject of a special charging section, viz., section 102 of Act, although the charge was to be ‘according to and under and subject to the provisions by which the duty in the third case of Schedule (D) may be charged.’ The section is a long one, and without further quoting it I think its provisions as affecting the present question may be summarised thus Where an annuity was payable out of profits or gains brought into charge by virtue of the Act of 1842 no direct assessment was to be made on the annuitant, but such profits or gains were to be assessed in full, with right to the person assessed to deduct and retain the portion of the income tax paid by him corresponding to the annuity. But where an annuity was not paid out of such profits or gains, the annuitant was to be assessed direct. Section 104 contained a somewhat cumbrous arrangement for providing the person paying the tax with a certificate entitling him to deduct and retain.

When the Income Tax Act 1853 was passed, it was seen to be convenient to include interest of money, annuities, &c., in the altered Schedule (D) contained in that Act, section 2. And section 40 provided for dispensing with the certificate required by the Act of 1842, section 104, and enacted that every person liable to the payment of any annuity, either as a charge on any property or as a personal debt, ‘shall be entitled and is hereby authorised on making such payment to deduct and retain,’ &c. This enactment was so far a complement of section 102 of the Act of 1842. Income tax on annuities payable out of profits and gains chargeable was already provided for. As regards such, all that section 40 did was to dispense with the certificate. But it gave the person liable in payment of an annuity not so payable the option to deduct and retain. It did not, however, make this course compulsory, and, apparently by an omission, it did not impose any obligation on the person paying the annuity and deducting the tax to account to the Crown for the tax so deducted.

In relation to the law as it stood after the passing of the Act of 1853, an important decision in the House of Lords— The Gresham Life Assurance Society v. Styles, L.R., (1892) AC 309—was quoted. In the case of this society the assessment was then made on profits and gains in the trading sense, not on the income from its invested accumulated funds. It, like other insurance companies and societies, dealt in annuities, and the question was whether, in ascertaining its annual profits and gains, it was entitled to deduct the amount of the annuities which it paid away. It was held that the society was a commercial concern, and could not strike its profits without allowing for the cost of the article supplied, and as part of its adventure consisted in selling annuities, what it paid as annuities was in its case the cost of the article supplied. Though decided after the passing of the Act of 1888, the question had arisen at an earlier date.

That Act, as was pointed out in the London County Council case, supra, was passed to stop the gap left by the Act of 1853. The tax on annuities payable out of profits and gains was already fully provided for. Henceforth the tax on all annuities not so payable was to be deducted and retained, not optionally but compulsorily, by the person liable in payment of the annuity, but with an obligation to account to the Revenue for the tax so deducted.

The precise terms of section 24 (3) of the Act of 1888 are—… [ His Lordship read the terms of the section, quoted supra],

It has been decided ( London County Council, supra) that ‘charged with income tax under Schedule D’ means simply charged under Schedule D with income tax, there being no difference occasioned by the schedule in the tax imposed but only in the method of imposition, and hence that the expression ‘payable out of profits or gains brought into charge to such tax,’ and again, ‘paid out of profits or gains brought into charge,' means brought into charge to income tax generally and not in any way limited to the cases provided for by Schedule D. Now, as Lord Macnaghten pointed out, ‘it is to be observed that the expression “profits orgains,” which occurs so often in the Income Tax Acts, is constantly applied without distinction to the subject of charge under all the schedules.’ Accordingly it Was held that as the London County Council paid the interest on their consolidated stock to the extent of £100,000 out of the income from lands, assessed to income tax under Schedule A, to the extent of £500,000 out of the interest of the council's loans to minor local authorities, already taxed at the source, and only to the extent of £500,000 from rates, that while it was entitled and bound to deduct income tax from all interest payable by it, it was entitled to retain that portion which corresponded to the proportion paid out of its

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income from land and from interest receivable, and was only bound to account to the Revenue for that portion which corresponded to the proportion paid out of rates. To construe the enactment otherwise was recognised to result in taxation of the same income twice over, which was contrary to the principle uniformly adopted in the Income Tax Acts from the first imposition of the tax, which an amending and not a charging provision could not be intended to affect.

It appears to. me that this judgment affords an authority for the disposal of the case before me. It is true that the circumstances differ in detail, but not as affecting principle. It has been held by a series of decisions— Scottish Mortgage and Investment Company of New Mexico, 14 R. 98; Northern Investment Company of New Zealand, 14 R. 734; Clerical, Medical, and General Life Assurance Society, L.R., 22 QBD 444 (450); Edinburgh Life Assurance Company, (1906) 5 Tax Cases 221—that it is in the option of the Inland Revenue to assess the income tax in any manner that the schedules, cases, and rules of the Income Tax Acts allow, and to ignore profits and gains in the popular or trading sense so as to produce the largest return to the Revenue. But it seems to me that having exercised their option, the Inland Revenue authorities must stand by their election.

Had the Inland Revenue elected to assess the Edinburgh Life Assurance Company, as in 1883–85they assessed the Gresham Assurance Society upon its profits, and gains in the trading sense, it would, in the quinquennium to which I have referred, have received tax upon £334,450 of net profits, together with the tax upon £218,463 of annuities paid away, or upon £552,913 in all, and the company's income from their invested accumulated funds, or £804,731 plus the amount of tax actually deducted from that income, would have formed an item in arriving at the net amount of profits. As it is, the Revenue, discarding trade profits, have recovered the tax on the company's income from invested accumulated funds, or on the gross income of which £804,731 is the net after deducting income tax. The Revenue have thus taken that mode which produced by far the larger return to the Crown (an assessment on trading profit plus an assessment on annuities paid would have given only five-eighths of what was actually received), and to allow the Revenue to recover the tax effeiring to the annuities, in addition to that received on invested income, would be to sanction the taxing over again in part at least of the same income, just as much as the course proposed to be taken in the London County Council case would have done. And this, it has been held, was neither the intention nor the effect of the Act of 1888.

Looked at from another point of view, it was recognised in the London County Council case, supra, that it was the duty of the managers of every commercial concern to follow the business-like course of keeping down current obligations out of current income. The Edin burgh Life Assurance Company were therefore entitled, and naturally as a business concern bound, to keep down their current obligations for annuities by paying them out of current income from invested funds. That income was profit and gain in the wider sense of the 24th section of the 1888 Act, and having paid the tax, the company were entitled to treat their current annuities as paid out of their own current interests and dividends from invested funds, and to deduct and retain in a question both with the annuitants and the Revenue. If this result altered what the Commissioners conceived it profitable for the Crown to do, it was open to them to exercise their option so as to meet the emergency, but not so as to tax the same income twice.

In some circumstances it is possible that a similar distribution of the tax deducted from annuities might have to be made, as was done in the London County Council case, supra. But the figures in the present case to which I have referred make it unnecessary to go into that point. I do not therefore require to consider the matter adverted to at the outset, and reserved.

“The defenders will therefore fall to be entirely assoilzied, with expenses.”

The pursuer reclaimed, and argued—The annuities were not paid out of profits or gains brought into charge by virtue of the Income Tax Acts. They were not a part of the company's profits, but were disbursements which the company had to make before it earned its income or made its profit— Gresham Life Assurance Company v. Styles, [1892] AC 309, 62 L.J., Q.B. 41. The fact that the assessment was there made, not as here upon income from investments but upon trading profit, made no difference. The Crown had the right to select as a basis on which the duty was to be charged either commercial profits or interest from investments, each being “profits or gains” within the sense of the Acts— Revell (Surveyor of Taxes) v. The Edinburgh Life Assurance Company, June 28, 1906, 5 Tax Cases 221; Scottish Mortgage and Investment Company of New Mexico v. Inland Revenue, November 19,1886, 14 R. 98, 24 S.L.R. 87; Surveyor of Taxes v. Northern Investment Company of New Zealand, May 31, 1887, 14 R. 734, 24 S.L.R. 530. The annuities, accordingly, not having been aid out of profits, the company were bound under the Act of 1888, section 24 (3), to deduct income tax therefrom and to render an account thereof to the Commissioners— The Attorney-General v. The London County Council, [1907] A C 131; Lord A dvocate v. Corporation of Edinburgh, October 15, 1903, 6 F. 1, 41 S.L.R. 1, and July 6, 1905, 7 F. 972, 42 S.L.R. 691; Commissioners of Supply for Aberdeenshire v. Russell, June 14, 1890, 17 R. 942, 27 S.L.R. 759. The distinction between the present case and The London County Council v. The Attorney-General, [1901] AC 26, 4 Tax Cases 265, was that the London County Council was not a company trading in annuities; the interest was not an outgoing

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or expense necessary to earn a profit, but the County Council acted merely as a conduit pipe for the interest or dividends.

Argued for the defenders and respondents—The case depended upon the construction of section 24 (3) of the 1888 Act, and the construction of that section could not turn upon the decision in the Gresham, case ( cit. sup.), which depended on the law prior to that Act, the assessment there in question being for the year 1885–1886. The annuities were there held not to be paid out of “such profits or gains” (1842 Act, section 100, Schedule D, 1st case, rule 4), i.e., not to be paid out of the balance of profits and gains, or the commercial profit. Such a construction of profits or gains as used in the 1888 Act, section 24 (3), would be inconsistent with The London County Council cases ( cit. sup.) The present case fell under the principle of the first London County Council case, and the company were bound to account to the Crown for the tax deducted. The contrary result would involve double payment of the income tax deducted. The only cases in Scotland in which The London County Council v. The Attorney-General, 11901) A.C. 26, appeared to have been cited were The Lord Advocate v. Corporation of Edinburgh ( cit. sup.), and Dalrymple v. Dalrymple, February 4, 1902, 4 F. 545, 39 S.L.R. 348.

At advising—