Scottish Court of Session Decisions

The Finance (No. 2) Act 1915 (5 and 6 Geo. V, cap. 89), Part III, deals with Excess Profits Duty, and sec. 40 (1), therein, enacts—“The profits arising from any trade or business to which this Part of this Act applies shall be separately determined for the purpose of this Part of this Act, but shall be so determined on the same principles as the profits and gains of the trade or business are or would be determined for the purpose of income tax, subject to the modifications set out in the First Part of the Fourth Schedule to this Act and to any other provisions of this Act.”

The Income Tax Act 1842 (5 and 6 Vict. cap. 35), sec. 100, Schedule D, First Case, Rule 1, applying to the first case, enacts—“The duty to be charged in respect thereof shall be computed on a sum not less than the full amount of the balance of the profits or gains of such trade …” Rule 1 applying to both the First and Second Cases, enacts—“In estimating the balance of the profits or gains to be charged according to either of the first or second cases, no sum shall be set against or deducted from, or allowed to be set against or deducted from, such profits or gains for any disbursements or expenses whatever, not being money wholly and exclusively laid out or expended for the purposes of such trade.”

David Alexander Small, carrying on business under the name of William Small & Son at 106 Princes Street, Edinburgh, appellant, being dissatisfied with an assessment to Excess Profits Duty in the sum of £904, made upon him under Part III of the Finance (No. 2) Act 1915, in respect of the profits of his business as outfitter, for the

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accounting period of twelve months ending 19th February 1917, appealed by Stated Case in which Alexander Easson, surveyor of taxes, on behalf of the Inland Revenue, was respondent. He claimed that in computing the said assessment the sum of £83, 19s. should be deducted in respect of expenses incurred in replacing a bond over the property used for the purposes of the business, which bond had been called up on the death of the bondholder.

The Case stated—“1. The following facts were admitted or proved—(1) David Alexander Small is the sole proprietor of the business of outfitter carried on at 106 Princes Street, Edinburgh, in the name of William Small & Son. (2) He is also the sole owner of the premises at the said address in which the said business is carried on. He purchased the said premises for the purpose of the business, and never at any time used them except as an asset of the business and the vehicle of the trade. The premises are entered in the valuation roll for the year 1916–17 as owned by D. A. Small, the appellant, and as occupied by William Small & Son. (3) For some time prior to the beginning of said accounting period the premises at 106 Princes Street were bonded to the extent of £23,300 under five separate bonds. (4) In 1915 James Kenneth, one of the bondholders, died, whereupon his executors proceeded to call up the money due under a bond amounting to the sum of £9300. There was repaid by the appellant £300 thereof at Martinmas 1915, and the executors allowed payment of the balance of £9000 to be postponed for six months. Thereafter Robert Kenneth, one of the beneficiaries of the said James Kenneth, entered into an arrangement whereby he agreed to take over the said bond, which was further reduced by the repayment of £500 to £8500. He duly obtained an assignation of the said bond, the arrangement with the appellant being that the latter was to pay an increased rate of interest and to repay the principal sum at the first term of Whitsunday or Martinmas after the war. (5) In connection with the assignation of the said bond certain legal expenses were incurred by the appellant amounting to the said sum of £83, 19s.

2. It was contended on behalf of the appellant—( a) There are two questions which must be investigated and answered, and which must on no account be confused The first question is—whether the sum proposed to be added to the total represented as the ‘balance of profits and gains’ of the firm in the sense of the Acts is one of the prohibited deductions? The second question, assuming this to be answered in the negative, is—whether in ascertaining profits of a trade, on the ordinary principles of commercial trading, the legal expenditure incidental to maintaining borrowed capital ( a) were profits or gains in any known business sense; or ( b) were rather expenditure necessary to earn the actual income shown in the balance sheet? ( b) As regards the first question the only prohibited heading referred to by the surveyor in correspondence or in argument was that part of rule 3 under the 1st Case of section 100 of the 1842 Act, which prohibits deduction ‘for any sum employed or intended to be employed as capital in such trade, manufacture, adventure, or concern.’ The appellant has never understood how it can be maintained that the expenses once and for all incurred in maintaining or renewing a sufficient working capital, when it is in danger of being withdrawn, are sums employed as capital. They yield no annual return, and are never expected to do so. Such expenses are expenditure for work done, and are in no sense income or gain except in so far as they enter into the profits of the legal firm engaged where they yield tax. They are strictly of the same nature as the repairs and renewals of premises or implements which are recognised on an average of three years by the same rule. ( c) As regards the second question, the statutory provision is that the tax is to be computed on a sum ‘not less than the balance of profits and gains.’ For the appellant it is argued that the sum in question cannot be in any sense part of the balance, and it was maintained that where a firm or concern is carrying on a business on a scale beyond the possibilities of its own private capital, the inevitable expenses involved in obtaining a supply of working capital is plainly expenditure necessary to the earning of the profits which (roughly speaking) vary with the size and turnover of the business. The charges and expenses of obtaining working capital on loan from a bank have never been and ought not to be computed as part of profits. They are not profits in any sense whatever.

3. The Surveyor of Taxes, Mr A. Easson, contended on behalf of the Crown—( a) That the deduction was inadmissible, as not being money wholly and necessarily laid out or expended for the purpose of the trade, within the meaning of the first rule of the rules applying to Cases 1 and 2 of Schedule D, section 100, of the Income Tax Act 1842. ( b) That the expenditure fell upon the appellant in his capacity as owner of the property in which the business was carried on, and not as proprietor of the business, and was consequently in the nature of a capital expenditure and not a trading expense; and quoted in support of his contentions the cases of Anglo-Continental Guano Works v. Bell, 1894, 70 L.T.R. 670, 3 T.C. 239, and Texas Land and Mortgage Company v. Boltham, 1894, 63 L.J., Q.B. 496, 3 T.C. 255.

4. The Commissioners on consideration of the facts and arguments submitted to them were of opinion that the amount claimed was not an admissible trading expense, and confirmed the assessment accordingly.”

Argued for the appellant—The expression “balance of the profits or gains” in the Income Tax Act 1842 (5 and 6 Vict. cap. 35), sec. 100, Sched. D, First Case, Rule 1, meant the balance of profits or gains of the business as estimated on ordinary principles of commercial trading, except in so far as expressly altered by the Act— Usher's Wiltshire Brewery, Limited v. Bruce, [1915] AC 433,

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per Lord Loreburn at p. 444, Lord Atkinson at p. 452, Lord Parker at p. 457 et seq., Lord Sumner at p. 467 et seq., and Lord Parmoor at p. 473 et seq. In the present case the expense of assigning the bond was a proper charge against revenue on ordinary principles of commercial trading, and there was nothing in the Act which prohibited its being charged against revenue. The expenditure was incurred “wholly and exclusively” for the purposes of the business within the meaning of the First Rule of the rules applying to both the First and Second Cases of Schedule D. It was incurred primarily and mainly for the purposes of the business. It was necessary to maintain sufficient working capital for the purposes of the business, and the paramount purpose of the expenditure was to protect the business premises, because if the appellant had not got the bond assigned, the creditor might have sold the business premises, a proceeding which would have ruined the business. Therefore the expenditure was incurred' “wholly and exclusively” for the purposes of the business within the meaning of the rule— Smith v. Lion Brewery Company, Limited, [1911] AC 150, per Lord Atkinson at p. 161 et seq. The mere fact that benefit may have enured to the appellant as owner of the property did not affect the matter— Ushers Wiltshire Brewery Company, Limited v. Bruce ( cit.), per Lord Sumner at p. 469 et seq., Lord Loreburn at p. 444 et seq., and Lord Atkinson at p. 451. In Usher's Wiltshire Brewery Company, Limited v. Bruce, the legal expenses of assigning leases and tenancy agreements were held to be proper charges against revenue, and an allowable deduction. See ibid. at [1915] A.C. 437, and report in 6 T.C. at p. 404. Anglo-Continental Guano Works v. Bell, [1894] 3 T.C. 239, was doubted in Scottish North-American Trust, Limited v. Inland Revenue, 1910 S.C. 966, 47 S.L.R. 832, aff. 1912 S.C. (H.L.) 26, 49 S.L.R. 114. See Lord Salvesen, 1910 S.C. 971 and 972, 47 S.L.R. 835 and 836; and Lord Johnston, 1910 S.C. 974, 47 S.L.R. 837, and Lord Atkinson, 1912 S.C. (H.L.) 31 and 32, 49 S.L.R. 116 and 117. Moreover, if interest on a loan was an expense analogous to the expense of assigning a bond, the analogy favoured the view contended for by the appellant, because interest on a loan was an allowable deduction in calculating profits in the case of excess profits duty—Finance Act (No. 2) 1915 (5 and 6 Geo. V, cap. 89), sec. 40 (1), Fourth Schedule, Part i, 2. Texas Land and Mortgage Company v. Holtham (1894) 3 T.C. 255, was distinguishable; it merely decided that the expense of procuring additional capital was not an allowable deduction. In the present case the expenditure was incurred, not for the purpose of securing new or additional capital, but for the purpose of preserving and maintaining existing capital. The expenditure was not incurred once and for all, but was of the nature of a recurring charge. The bond might be called up on a fortnight's notice. Thomson, Black, & Company v. Inland Revenue, 1919 S. C. 289, 56 S.L.R. 185, was also distinguishable. In that case the expenditure was incurred in connection with the distribution of the profits of the trade. Moore & Company v. Inland Revenue, 1915 S.C. 91, 52 S.L.R. 59, was also distinguishable. In that case the expenditure “was money which was laid out for the purpose of establishing a new and independent business,” per Lord Skerrington, 1915 S.C. 99, 52 S.L.R. 63. Moreover, Lord Johnston dissented.

Argued for the respondent—The expense of assigning the bond was not an allowable deduction, because it was not expenditure necessary to earn the profits of the trade. Where expenditure had been allowed as a deduction, there had always been a direct relationship between the expenditure and the earning of the profits, but in the present case there was no such direct relationship between the expenditure and the profits of the appellant's outfitting business. Expenditure was not allowable as a deduction unless it had been incurred “wholly and exclusively” for the purposes of the trade, but in the present case the expenditure had not been incurred “wholly and exclusively” for the purposes of the appellant's business. It had been incurred by him in his capacity of owner of the shop. Expenditure was not allowable as a deduction unless it was annual, but in the present case the expenditure was not an annual outlay— Thomson, Black, & Company v. Inland Revenue ( cit.); Dumbarton Harbour Board v. Inland Revenue, 1919 S.C. 162, 56 S.L.R. 122; Moore & Company v. Inland Revenue ( cit.); Strong & Company, Limited v. Woodifield, [1906] AC 448; Ashton Gas Company v. Attorney-General, [1906] AC 10; Texas Land and Mortgage Company v. Holtham ( cit.).

At advising—