Scottish Court of Session Decisions

LORD PRESIDENT (Normand).—This is an appeal against a determination of the General Commissioners, who have held that a payment of £1500 made to the appellants as compensation for terminating an agency agreement should be included in computing the taxable profits for the year in which the payment was made.

The appellants are manufacturers' agents who began business in 1914 as agents for various manufacturers for the sale in Scotland on a commission basis of such manufacturers' products. One of their agencies from the outset was for the sale of the products of George Ellison, Limited, of Birmingham. The terms of the contract between the appellants and George Ellison, Limited, were, in the ordinary course of the appellants' business, modified from time to time. I refer to the letters which are incorporated in the case and which show the successive variations which were made. In 1934 the agency contract then current was to run until the 30th of September 1935. I am in doubt whether it could be terminated only if either party gave 12 months' notice before the 30th of September 1935. But this doubt is not material in the events which have happened. For in May 1934 Messrs Ellison requested that the agency agreement should be terminated forthwith for reasons which in no way reflected upon the appellants; negotiations followed, and on the 26th of May 1934 Messrs Ellison embodied the results of these negotiations in a letter in which they state, "As compensation for terminating the agreement on September 30th, 1934 instead of September 30th, 1935 we pay you on October 1st 1934 the sum of £1500, this sum to cancel all obligations on either side." The effect of this was that the agency agreement continued to operate for all but the last year of its full contemplated life, and in respect of its cancellation one year before its contemplated term the appellants received the £1500 in name of compensation.

To begin with the Ellison agency was one of two agencies held by the appellants, but in the years 1930 to 1934 the appellants held between 9 and 11 agencies. The Ellison agency was, however, in the five years lucrative, and yielded sometimes as much as one-half of the total gross commission received by the appellants. In the last year of its currency the commission received from Messrs Ellison was £2000, and the total receipts by the appellants amounted to £4259, 8s. 7d. In the year 1935 the gross receipts fell to £2668, 12s. 3d., if the £1500 received from Messrs Ellison, which is the subject of contention in the present appeal, is excluded. In order to fulfil adequately their agency contract with Messrs Ellison the appellants employed two salesmen at considerable salaries, and they also acquired two motor cars, to the cost of which a contribution was made by Messrs Ellison. On the termination of the contract the two motor cars were retained by the appellants for use in their business, and they also retained in their service one of the two salesmen. The other salesman left and obtained another appointment. The whole of the expenses incurred by the appellants in respect of their sales service for Messrs Ellison have been charged in the appellants' accounts in arriving at their profits, but no part of the £1500 received from Messrs Ellison has been credited in these accounts. The contention of the appellants before the Commissioners and before us is that the whole payment is a capital payment. The contention for the Crown on the other hand, which the Commissioners have sustained, is that the whole payment is an income payment. No case of apportionment as between capital and income has ever been suggested on either side.

It has been said by Lord Macmillan in Van den Berghs, Limited, v. Clark that the question whether a particular receipt should be dealt with as an income receipt or as a capital receipt cannot be solved by reference to any provisions of the Income Tax Act, and that no infallible criterion emerges from a consideration of the case law. Each case depends upon its own facts, and in this case the facts, which seem to me not to be closely analogous to the facts in any of the cases cited to us, lead me to the conclusion that the determination of the Commissioners should stand. The sum which the appellants received was, as the Commissioners have found, paid as compensation for the cancellation of the agency contract. That was a contract incidental to the normal course of the appellants' business. Their business, indeed, was to obtain as many contracts of this kind as they could, and their profits were gained by rendering services in fulfilment of such contracts. The appellants' business is entirely different from the business carried on by someone who, under contract, acts exclusively as agent for a single principal. In ordinary course this kind of contract was the only kind of contract that the appellants entered into for themselves in the course of their business, for, when they made a contract for the sale of their principals' goods, these contracts of sale were entered into not on their own behalf, but on behalf of disclosed principals. Further, these agency contracts might be for a fixed term, or they might be terminable at will. It was a normal incident of a business such as the appellants' that these contracts might be modified, altered, or discharged from time to time, and it was quite normal that the business carried on by the appellants should be adjustable to variations in the number and importance of the agencies held by them, and to modifications of the agency agreements, including modifications of their duration, which might be made from time to time. The history of this very contract exemplifies the normal modification of the agency contract as business circumstances required, and the power of adjustment to alterations in the agency contracts is strikingly exhibited in the year after the Ellison agency was terminated, when the number of agencies held by the appellants increased to 14 and the former level of profits was re-established. In parting with the benefit of the contract, moreover, the appellants were not parting with something which could be described as an enduring asset of the business. The contract would have been terminated in any event as at the 30th of September 1935. The appellants not only had no legal right to insist on the continuance of the agreement beyond that date, but they had after May 1934 no reasonable expectation, in view of the known attitude of Messrs Ellison, that the agreement would in fact be continued beyond September 1935. The agreement by which the agency contract was terminated at September 1934 therefore effected a surrender of one year's benefit, and in return for this surrender the appellants received compensation. We are not embarrassed here by the kind of difficulties which arise when, by agreement, a benefit extending over a tract of future years is renounced for a payment made once and for all. The sum paid in this case is really and substantially a surrogatum for one year's profits. In these circumstances the appellants' counsel failed to convince me that the Commissioners erred in treating the payment as an income payment in the year in which the appellants received it. It is perhaps worth noting that, in the appellants' accounts, they charge the whole expenses incurred by them in respect of their sales service for Messrs Ellison against their profits. I understand by that finding of the Commissioners that, in the accounts for the year ending September 1935, there are items of charge relating to the organisation which the appellants had kept up for this service. If that is so, I should not make the criticism that these items were improperly charged against the annual receipts, but I do say that there ought to be a corresponding entry of the sum of £1500 with which this appeal is concerned.

It is not necessary that I should review all the authorities which were cited to us, but I must advert to the contentions ably urged by the appellants' counsel that the determination of the Commissioners is contrary to principles recognised in some of these authorities. Counsel maintained that a payment for loss of a "profit-making apparatus" was necessarily a capital payment in the hands of the recipient who received it as compensation for such loss. This proposition is, I think, too vague and too wide. I find it impossible to reconcile with some of the decided cases, for example, Short Brothers v. Commissioners of Inland Revenue, and Commissioners of Inland Revenue v. The Northfleet Coal and Ballast Co. These two cases were referred to by Lord Macmillan in his speech in Van den Berghs, Limited, v. Clark, and I think they can be treated as of high authority since they passed the scrutiny of the House of Lords without adverse comment. Then it was urged that the whole structure of the appellants' business was affected by the cancellation, and that, on the authority of Van den Berghs, Limited, v. Clark, the payment should therefore be treated as a capital payment. I have already given reasons for thinking that the structure of the business carried on by the appellants was in fact, as the nature of the business required, so designed as to absorb such shocks as the cancellation of a single, albeit an important, agency contract. And it must be remembered that the loss of this agency agreement might be expected to take place in September 1935, and the consequential effects on their business had to be faced by the appellants as at that date. The shock, therefore, such as it was, consisted merely in this, that the end of the agency came by agreement 12 months earlier than its contemplated term. The Commissioners who heard the evidence had this contention fully before them and they rejected it. Again I am not persuaded that the Commissioners have committed any error. Their findings of fact include a finding that the appellants had to build up a considerable technical organisation which could neither be collected nor dispersed at short notice, but that is something which falls far short of what Lord Macmillan described in Van den Berghs's case as the fixed framework of the appellants' business. In my opinion the agency agreements entered into by the appellants, so far from being a fixed framework, are rather to be regarded as temporary and variable elements of the appellants' profit-making enterprise. I therefore move your Lordships to answer the question put to us in the affirmative.

LORD FLEMING .—I am of the same opinion. The business carried on by the appellants consists in acting as agents for the sale in Scotland for various manufacturers, on a commission basis, of such manufacturers' products. That means that their business is to get agencies from manufacturers, and to render services to their principals thereunder, and to earn profits out of the commission and other payments which they receive from their principals. It is accordingly an essential part of their business to enter into agreements such as the one here in question. Just as their principals could not carry on business without entering into contracts for the sale of their products, so the appellants could not carry on business without entering into agency agreements. One would suppose that it would be an ordinary incident of their business that such agreements might be altered or terminated from time to time. The agreement in question here was for three years, and it was terminated at the end of the second year at the instance of the principals, and a sum of £1500 was paid to the appellants as compensation for its termination. In terms of the arrangement for terminating the agreement, the payment fell to be made on 1st October 1934. I do not think it is doubtful that the parties must have had in view, in fixing this sum of £1500, that by the premature termination of the agreement the appellants would be deprived of the profits which they might expect to earn from the agreement during the year 1934–1935, and that they might also during that year incur expense in connexion with it, and the £1500 must be regarded as covering such loss. The Commissioners appear to have taken the view that it contained no other element or factor, and on the facts before them I think they were entitled so to hold. There is no finding that, in consequence of the termination of their agreement, any capital asset was depreciated in value or became of less use for the purpose of the appellants' business, or that what has been called the structure of the business received any disturbance other than it might be expected to receive in ordinary course. If the Commissioners were entitled to take the view that the payment of £1500 related entirely to the year 1934–1935, I am unable to say that they erred in holding that it was of an income character. We were not referred to any case which decided anything to the contrary, and the decision in Short Brothers v. Inland Revenue Commissioners appears to me entirely to justify the determination of the Commissioners. I wish to add that I attach importance to the fact that the agreement had only one year to run at the date of its termination. A different case would have arisen for decision if the agreement had been terminated when it had still, say, a period of 10 years to run. A payment made in respect of a loss to be sustained over a period of years may well have a different character from a payment made in respect of a loss to be sustained in the year in which the payment is received.

LORD MONCRIEFF .—I agree with your Lordships. The question whether a sum received by a trader as compensation for the cancelling of one of his trading contracts is to be regarded as a capital or a revenue sum must in each case, as very emphatically in the present case, depend upon the particular circumstances under which the payment has been made. As to these circumstances I agree with all that your Lordship has said. There appears, however, to have been a general distinction drawn in the cases which may be helpful in solving any particular problem. That distinction may perhaps be formulated as follows:—(1) A contract may be made by a trader which is merely directed to result in trading profits being made. (2) A contract may be made by a trader which is directed to regulate the conditions under which he is to carry on his trade.

An example of the latter class of contract was before the House of Lords in the case of Van den Berghs. In that case an English and a foreign trading company had entered into a pooling agreement which was to endure for a period of years. It was proposed, and eventually it was agreed by joint consent, to cancel that agreement at a period when, apart from cancellation, it would still have run for many years, and a payment was made by the foreign to the English company as compensation for the cancellation of their rights under the agreement. It was held that the payment received by the British company was to be regarded as a capital and not as a revenue payment, but the payment in that case had been made in respect of the cancellation of an agreement directed to result, not in the making, but only in the partition, of trading profits. The agreement which had been discharged had been an agreement directed to exclude competition as between the British and the foreign trader. Apart from the introduction of a conventional scheme effecting stabilisation by affecting distribution, the profits which each of the firms, British and foreign, were to enjoy, whether that agreement had or had not been made, were such profits as would result from their individual exercise of their trade. The only effect of the agreement was, by eliminating competition and restricting liberty, to render the market more favourable to both traders, in the view of the contracting parties, towards the making of trading profits, and, as the agreement was independent of any contract for the direct making of profits, it was held that the payment for its cancellation was to be regarded as capital. With such a case the present case, in my view, has no analogy.

The present case, in my view, is clearly an example of the contrasted class of case where the payment is made in respect of the cancellation of a contract directed to result in the making of trading profits. A typical example of such a case was considered by the English Court in the case of Short Brothers. In that case a shipbuilding firm had made a contract for the building of a ship. In the course of the execution of that contract the contract was cancelled by arrangement. A payment of compensation was made by the prospective purchaser of the ship to the builders, and the sum so paid was regarded and held by the Court to be a revenue and not a capital payment. The payment there had been made in respect of the cancellation of a contract which, had it continued to operate, was directed to result in the making of trading profits. It was the business of the shipbuilders to enter into contracts for the building of ships, and, having done so, to execute these contracts. In the present case it was the business of the appellants to enter into contracts for exclusive or local agencies for the selling of goods, and, having done so, to execute these contracts.

In the present case, as in the case of Short,cancellation of the agreement has resulted in the disturbance of the contracted profits of the appellants, and for such a loss, subject to one distinction, compensation when paid seems to share the revenue quality of the benefit in respect of the loss of which it has been paid. The distinction I would draw was incidentally recognised in the case of Short. The trading profits which had been contracted for in that case were trading profits which were to be ingathered within what I may call the revenue period of the outlook of a shipbuilding business. The revenue period of each particular business of course will vary, but profits can in general be said to fall within the revenue period which are payable within the time which in ordinary course is granted for the execution of the contracts which the trader is in use to make. In this case accordingly where, in the event which happened, payment was made of a single sum in lieu of the single sum which would have been payable under the agreement if not cancelled within a year, I regard the profits, of the contracted prospect of which the appellants sustained a loss, as being profits within the outlook of realisation within the revenue period of their particular business.

If, on the other hand, an agreement such as this, although directed towards resulting in the making of trading profits, has an outlook over a period of years, then I agree with Lord Fleming that disturbance of such an agreement, although associated with the disturbance of a prospect of the making of trading profits, may be the disturbance of what should properly be regarded as a capital interest. A fair analogy may be taken by contrasting the case of an annuity for life with that of an annuity for a limited term of years. One who sells a life annuity parts with an asset which was properly a capital asset before the transaction, and the sum which he receives as the price of the annuity will properly be regarded as capital. If, on the other hand, there be a ten years' annuity payable to a person who, at the close of the ninth year, discharges his right to the annuity in return for payment of a single sum, and accepts that sum in lieu of the four quarterly instalments which may yet be payable, it seems to me clear (in any event for purposes of income tax) that he must be regarded as merely receiving a revenue sum for the disturbance of a revenue right. Accordingly, I agree with your Lordships that the appeal should be refused.

LORD CARMONT .—I agree with the views expressed by your Lordships and with the course proposed.