Scottish Court of Session Decisions

Thomas George Bishop and Andrew Henderson Bishop, grocers and tea merchants, Glasgow, first parties, and Mrs Margaret Graham Robertson or Nicol and others, the testamentary trustees of the deceased Robert Nicol, formerly a partner with the first parties in their business, second parties, brought a Special Case for the opinion and judgment of the Court for the determination of the proportion of profits payable to the second parties in name of goodwill under the contract of copartnery.

The Special Case stated, inter alia—“1. The first parties and the said Robert Nicol carried on business as grocers and tea merchants in Glasgow under the firm name of Cooper & Company, under a contract of copartnery dated 14th and 17th February 1912, and relative minute of agreement dated 20th and 23rd March 1917. [By the minute of agreement the copartnery was continued for three years.] 2. By article twelfth of the said contract of copartnery it was provided as follows, videlicet—‘In the event of any of the partners dying, and in consequence his interest falling to be ascertained and paid out, it shall be in the power of the surviving partners, provided they give the notice hereinafter referred to, to pay out the amount of such interest, which in such event shall be held to be the sums standing to his credit in the capital of the copartnery as may be shown by the half-yearly balance sheet preceding his death with a sum added thereto or subtracted therefrom, as the case may be, equal to the proportion of such deceased partner's interest in profits and losses for the period from the date of the balance prior to decease until the date of decease, the same being calculated on the basis of the profits or losses shown by the two previous half-yearly balance sheets. The surviving partners shall be bound within six weeks after the date on which the death of the deceasing partner comes to their knowledge to give notice to the representatives of the deceasing partner that they have resolved to exercise the foresaid power conferred upon them, and on the interest of such deceasing partner being so ascertained the amount thereof (together with the sum in name of goodwill as is hereinafter provided for) shall be paid out to his trustees.…’ 3. By article thirteenth of the said contract of copartnery it was provided as follows, videlicet—‘In addition to the sums payable as is before provided for in respect of the deceasor's right and interest in the copartnery, there shall be due and payable to the trustees and executors of the deceasor, in the event of the surviving partners electing to exercise the power conferred in the preceding article, a sum in name of goodwill, the amount of which shall be held to be a sum equal to the deceasor's proportion of the profits of the business for the four preceding financial years, after payment of interest on capital account as such profits shall be ascertained from the profit and loss accounts for the eight preceding half years of the copartnery, and if the amount of such profits fall to be ascertained prior to the copartnery being in existence for four years, then to the profits during the period in which the copartnery has been in existence there shall be added a proportion of the profits earned during the period requiring to make up the four years of the first party's previous copartnery with the said John Henderson, excluding, however, the last year of said previous partnership, the proportion being the same as in the case of the period following under this contract, videlicet—three-fifths in the case of the first party, and one-fifth in the case of the second and the third parties. As an illustration of the working out of this article, if the four years' profits equals a sum of £100,000, the proportion payable to the trustees and executors of the first party would be the sum of £60,000, and the proportion payable to the trustees and executors of each of the second and third parties would be the sum of £20,000. In the case of an insolvent partner, no sums shall be paid to his representatives in respect of goodwill.’ 4. The said Robert Nicol died on 8th September 1919, at a date when the copartnery had been in existence for more than four years, and the surviving partners, the first parties hereto, gave notice to his trustees and executors, the second parties hereto, that they intended in exercise of the power conferred upon them by article twelfth of the contract of copartnery to pay out the amount of the interest of the said Robert Nicol in the copartnery. 5. By section 38 of the Finance (No. 2) Act 1915 (5 and 6 Geo. V, cap. 89) it is provided as follows, videlicet—‘(1) There shall be charged, levied, and paid on the amount by which the profits arising from any trade or business to which this part of this Act applies, in any accounting period which ended after the fourth day of August Nineteen hundred and fourteen, and before the first day of July Nineteen hundred and fifteen, exceeded by more than Two hundred pounds the pre-war standard of profits as defined for the purposes of this part of this Act, a duty (in this Act referred to as “excess profits duty”) of an amount equal to fifty per cent. of that excess.’ 6. By subsequent Acts of Parliament the liability to excess profits duty has been continued, but the rate of the duty fixed has varied from time to time. 7. The parties are agreed that the business carried on under the said contract of copartnery was a business to which Part III of the Finance (No. 2) Act of 1915 and the subsequent Acts relating to excess profits duty applied. 8. The parties are agreed as to the correctness and accuracy of the balance sheets of the copartnery, but a dispute has arisen as to the ascertainment of the sum falling to be paid to the second parties in name of goodwill under

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article thirteenth of the contract of copartnery. 9. The excess profits duty payable in respect of the profits for any particular half-year was not paid out of the profits earned during that half-year, but was paid at a later date, and out of the profits earned during the half-year in which it was paid. It was charged in the accounts of the company for the half-year in which it was paid. The parties are, however, agreed that in the event of it being held that the excess profits duty falls to be deducted before arriving at the proportion of profits payable to the second parties in name of goodwill, the payments should be written back to the different half-years in respect of which they were payable. 10. The first parties maintain that in estimating under the said article the deceasor's proportion of the profits of the business for the four preceding financial years, the amounts paid in name of excess profits duty fall to be taken into account and treated as payments before the profits in the sense of the said article are arrived at. 11. The second parties maintain that in ascertaining the amount of profits payable to the second parties in name of goodwill no deductions fall to be made for payments made in respect of excess profits duty.” The question of law for the opinion and judgment of the Court was—“On a sound construction of said contract of copartnery do the sums paid in respect of excess profits duty fall to be deducted before arriving at the proportion of profits payable to the second parties in name of goodwill?”

Argued for the first parties—The deed showed that what was to be allowed in name of goodwill was the deceasor's share in the net profit. “Profits of the business” meant net profits. Excess profits duty was an expense of the business. As such it was within the knowledge of the partners at the date of the extension of the copartnery in 1917. It was not a personal tax but a tax on the business, and was expressly created a charge on a special fund. It was further an emergency tax, and there was no warrant for inflating the profits for the purpose of goodwill so as to give the deceasor a larger share than he otherwise would have had. In this respect excess profits duty was different from income tax, and it was assessed according to special rules. Further, by section 35 of the Finance Act (No. 2) 1915 (5 and 6 Geo. V, cap. 89), re-enacted in the Finance Act 1918 (8 and 9 Geo. V, cap. 90), Sched. D, Cases I and II, Rule 4, sub-section 1, it was provided that excess profits duty should be deducted before the fund for income tax was arrived at. This exhibited it in its true light as a charge on the business—an expense or outgoing of the business. In Patent Castings Syndicate, Limited v. Etherington, [1919] 2 Ch. 254, net profits were interpreted as the fund available for division after deduction of excess profits duty— ibid., per Warrington, L.J., pp. 265–6, 267, Duke, L.J., p. 272, and Eve, J., p. 275. This decision approved and followed in re Condran, [1917] 1 Ch. 639, where the same principle was stated, per Peterson J., at p. 644. Further, the fact that no question arose on the revenue item was highly significant in answering this question, because it had never been maintained that in measuring out this revenue payment the deceasor's proportion could cover profits without deduction of excess profits duty. Similarly it was clear that the share of each partner in the goodwill must be determined by his revenue interests. It was entirely fallacious to consider only the partner whose interest was being paid out. The case of William Hollins & Company v. Paget, [1917] 1 Ch. 187, founded on by the second party, could not stand with the case of Patent Castings Syndicate, Limited v. Etherington.

Argued for the second parties—This case was distinguishable from the English cases founded on by the first parties, in respect that these dealt with contracts between partners under which were to be distributed between them the fruits of the year's trading. In the present case the question was as to the value of a capital item, viz., goodwill, and the reference to profits was merely made for the purpose of arriving at that item. That was a sum equal to the deceasor's proportion of the profits of the business, but was not necessarily what he actually received. Profit was all that came in, less the expense of earning it. Net profit, however, was profit available for division among the partners or as dividend. It would not, for example, include reserve fund. In Fisher v. Black and White Publishing Company, [1901] 1 Ch 174, this distinction was clearly recognised. Unless net profits were expressly mentioned there was no warrant for taking off excess profits duty in arriving at goodwill. In this respect it was similar to income tax. In Patent Castings Syndicate, Limited v. Etherington the word used was “net,” per Warrington, L.J., at p. 264, and per Younger, J., [1919] 1 Ch. 306. In William Hollins & Company, Limited v. Paget, [1917] 1 Ch. 187, the word used was “profits,” not “net profits,” and excess profits duty was held not to be deductible. This decision was recognised as sound in Patent Castings Syndicate, Limited v. Etherington ( cit. sup.), per Warrington, L.J., p. 269, foot. In re Condran was to the same effect as Patent Castings Syndicate v. Etherington, and interpreted “net profits” as profits available for dividend. To the same effect were Thomas v. Hamlyn & Company, [1917] 1 K.B. 527, and Johnston v. Chestergate Hat Manufacturing Company, [1915] 2 Ch. 338. It did not follow that the remaining partners would bear all the excess profits duty if the second parties' contention was sustained. Repayment was provided for under the Act if the profits fell, and they might quite well get it back in future years. Excess profits duty was meant to be a temporary war impost. There was nothing surprising therefore in not treating it as a fair deduction in estimating goodwill, more especially when, by the nature of the legislation imposing it, it was constituted an insurance fund to meet losses, was subject to repayment, and so far as repaid was subject to income tax. If the first parties' argument were right the claim for repayment would be a benefit which was not to be paid for by the surviving partners but by the deceasor.