TMI Blog1951 (5) TMI 4X X X X Extracts X X X X X X X X Extracts X X X X ..... China, the trade being carried on on a Chinese dollar basis. For the purpose of this trade the company employed a considerable number of Chinese agents to whom petroleum products were consigned and who did not pay before-hand for the products which were consigned to them, but were required by the terms of their contracts to deposit with the company certain sums in Chinese dollars, so that if they defaulted for any reason in payment for the products consigned to them the company would have in hand something to meet the amounts due. The deposits were made, with relatively trifling exceptions, in Chinese dollars and at 31st December, 1936, the liability of the company to return deposits of this kind exceeded the sum of seven million Chinese dollars--which at that time was equivalent to 430,559, the Chinese dollar at that time being equivalent in value to about 1s. 3d. The company was empowered to use the sums which were obtained by means of these deposits in any way the company liked. The company did in fact keep in Shanghai banks Chinese dollar deposits to an amount equivalent roughly to the sum which the company had acquired from these agents at any given time. When war broke o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sable to tax under Case I of Schedule D. Sir Andrew Clark has referred me to a certain number of authorities which I should like, first of all, to mention. The first case is the case of McKinlay v. H. T. Jenkins Son, Ltd.(1) That was a case in which a company which was concerned with marble purchased lire in order to meet the payments on marble which would have to be paid in Italian lire at a later date. Before the time for payment arrived the company, seeing a chance to make a profit, sold lire (which were originally bought for 103 to the pound) at a rate of 72 to the pound and then repurchased further lire to pay off its indebtedness at the rate of 103 lire to the pound and consequently gained an accretion through this method of dealing with the exchange. Sir Andrew distinguished that case on the ground that it was a mere speculation and has nothing to do with the company's trade. Mr. Grant, on the other hand (who appears on behalf of the company) said that he did not rely on this case in any way and therefore we might treat that case as being different from the present one and one which does not affect the matter one way or the other. There are three cases upon which S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r, in September, 1939, the appellant company, at the request of the Treasury, stopped all further purchases of tobacco leaf in the United States, and, as a result, the company had on hand a holding of dollars which had been accumulated between January and August, 1939. On 30th September, 1939, the company was required under the Defence (Finance) Regulations, 1939, to sell its surplus dollars to the Treasury, and, owing to the rise which had occurred in the dollar exchange, the sale resulted in a profit for the company. This profit was included in assessments upon the company to income tax under Schedule D, Case I, and to National Defence Contribution. On appeal to the Special Commissioners, the company contended that, in the events which had happened, the profit was a realised appreciation of a temporary investment in foreign currency, and not a profit of its trade. The Commissioners found that the profits from the sale of dollars to the Treasury had been correctly brought into the computation of the profits of the company's trade, and dismissed the appeals: Held, that the profit made by the company on the compulsory sale of surplus dollars to the Treasury must be included in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng off that obligation. It seems to me that this is a matter of considerable difficulty. The company was not trading in dollars ; it was trading in petroleum products and therefore it was not really an acquisition of money or a profit in respect of its stock. On the other hand, that is not, perhaps, the end of the matter, because circulating capital may result in accretions which have to be brought into account for the purpose of ascertaining the company's liability for income tax. As it seems to me the question is largely, if not entirely, a question of fact. The company of course did not keep the deposits intact; it merely paid them into its dollar balances originally at its Shanghai bank and then included them in a sterling deposit with the Shell Petroleum Company. Was the diminution of the liability which resulted in a smaller call upon those sterling deposits a matter affecting the fixed capital or was it one which was concerned with the circulating capital of the company? It seems to me that there is a very illuminating passage--as regards the difference between circulating capital and fixed capital -to be found in the judgment of Romer, L. J., in the case of Golden Horse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of his fixed capital. The land with which a dealer in real estate carries on his business is part of his circulating capital. The machinery with which a manufacturer makes the articles that he sells is part of his fixed capital. The machinery that a dealer in machinery buys and sells is part of his circulating capital, as is the coal that a coal merchant buys and sells in the course of his trade. So, too, is the coal that a manufacturer of gas buys and from which he extracts his gas. For the purpose of ascertaining his profit in a year, it is clear that he must debit his profit and loss account with the purchase price of the coal that he treats in the course of that year, and that, too, whether he buys it in that year or buys it in advance. It is part of the cost of producing the gas that he sells. Such cases as these cause no difficulty. But now suppose that the gas manufacturer, instead of buying his coal from outside sources, purchases a coal mine and produces the coal that he requires by mining. The cost of extracting from the mine the coal treated will, of course, be a permissible deduction in ascertaining the profits of his business in the year. But he may not debit his profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the company was free to use the moneys for the time being in its hands for investment as part of its fixed capital, and did in fact so use them, and not as circulating capital for the purpose of carrying on its trade. Consequently the profit on exchange was a capital profit/' In this case the company was free to use the amounts of these deposits for any purpose it liked ; they were in no way held on trust for the agents in question and the company did in fact simply mix them with its general deposit account, no doubt. It seems to me that the method in which it dealt with the transaction was none the less material. It always kept sufficient in hand to meet this obligation and therefore in a sense, as it seems to me, kept fixed capital available to meet that liability, and when that liability came to be discharged the amount of the liability, as Sir Andrew Clark truly said, had diminished, and therefore, it was a gain to the company. It seems to me that that is evidence upon which the Commissioners could reach the conclusion which they did. It has been stated as a question of law for me to decide, whether the Commissioners were right in holding that the profits in question were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Each agent's deposit was accompanied by a note or memorandum of agreement signed by the agent and countersigned on behalf of the company. I shall have to refer later to the details of the agreement, a specimen of which is set out in the case. For the moment it is enough to say that the deposit was a deposit made in Chinese dollars in China, repayable in Chinese dollars in China on the termination of the agency, and in the meantime, during the currency of the agency, held by the company as security for the due performance by the agent of his obligations, with power to the company to take out of the deposit any amounts which might become due from the agent in the event of his default. The practice of the company prior to the end of 1936 was to retain in banks in China on deposit account dollar balances substantially corresponding to the amount of the company's liability to agents in respect of deposits received. On 31st December, 1936, the company had in hand Chinese dollar deposits received from agents to the sterling equivalent of ? 4,30,559. As against that the company had on deposit account with Chinese banks sums in Chinese dollars to the sterling equivalent of ? 4,2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ectively. Owing to the fall in the rate of exchange the company was able to acquire these dollars at prices very much lower than the price at which it had effected the conversion of its former dollar holdings into sterling. The net result was that by the end of the year 1941 the company had paid off the greater part of the deposits due to its agents and was left with a balance representing the excess of the proceeds of conversion of its former dollar holding as compared with the amount it had to lay out in the purchase of dollars at the lower rate in order to pay off the agents' deposits. The amount of the difference was the ? 229,475 claimed by the Crown, and so far unsuccessfully claimed, to constitute a profit of the company's trade. There were, it appears, as many as 600 agents operating for the company in China, and it further appears that the appointment of agent for the company was considered a valuable appointment in China, and that as a rule these agencies continued for long periods. I should next read the specimen form of deposit note, which is set out in paragraph 6 of the case. This is a translation of the form of agreement, the original presumably being i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ignature and space for the name of a witness. Then there are these words: We hereby acknowledge the receipt of the above-mentioned deposit on the above-mentioned terms and the signature of the company. The points to be noticed as to the character of the payment made by an agent under that form of agreement and as to the essential features of the bargain recorded by it are these: The sum paid is a deposit; it is to stand as security for, to put it shortly, the fidelity of the agent so that in the event of default by the agent it may be applied in discharge of sums due from him in respect of sales of petrol or the like. It is not however a payment in advance because what it contemplates is that it shall remain as a standing deposit throughout the period of the agency, and recourse shall not be had to it except in the case of default. It has the character of a loan in that it is repayable at the determination of the agency by the company, and also in that it has to carry interest at a fixed rate per cent. per annum. It is a deposit made in dollars and repayable in dollars. I think those are the relevant points about the deposit agreement. It is obvious that when a company base ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h are somewhat complicated. The question for decision so far as this Court is concerned is a question of principle and any details of figures are to be agreed by the parties or, failing agreement, by some further procedure. The stated case sets out the facts which I have summarised, and proceeds in paragraph 17 as follows: It was contended for the company that the deposits received by it from its agents were used by it, not as circulating capital, but as fixed capital, and that the profits made on exchange were capital profits and not subject to income tax. Paragraph 18 says: It was contended for the Crown that the said agents' deposits, to which the company could have recourse in the case of any default by agents, were circulating capital, and that the profits on exchange were made in the course of the company's business, and must be included in the computation of its profits and gains for the purpose of assessment to income tax. Reference is then made to a number of cases which had been cited before the Special Commissioners. The part of the case to which I shall next refer is paragraph 21 which sets out the Commissioner's findings. I think I had better read ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of law for the opinion of the Court is whether we were right in holding that the exchange profit in question was a capital profit not subject to income tax. The learned Judge, Danckwerts, J., on appeal affirmed the Special Commissioners' finding. He set out the facts, and he referred to the authorities, to which I must return, bearing on profits on exchange and the circumstances in which they are to be considered as trading profits. He also referred to the case of Commissioners of Inland Revenue v. J. Gliksten Son, Ltd.* which was in a sense an analogous case of a trader whose stocks of timber were destroyed by fire. As a result he received payment under an insurance policy. The question--decided in the affirmative--was whether that payment was a trading receipt. The learned Judge at page 4 of his judgment said this: As it seems to me the question is largely, if not entirely, a question of fact. The company of course did not keep the deposits intact; it merely paid them into its dollar balances originally at its Shanghai bank and then included them in a sterling deposit with the Shell Petroleum Company. Was the diminution of the liability which resulted in a small ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idence upon which the Commissioners could reach the conclusion which they did. It has been stated as a question of law for me to decide, whether the Commissioners were right in holding that the profits in question were capital profits not subject to income-tax; but that seems to me to be not a question of law but a question of fact and, the Commissioners really being the people to decide questions of fact, it seems to me I am not entitled to interfere with that finding. I think there was evidence upon which they could reach the conclusion they did reach, and for that reason the appeal must be dismissed. It appears therefore that all the learned Judge ultimately did was to decide that the question in this case, that is to say, whether the sum of ? 229,475 was a trading profit or a mere capital profit, was a question of fact on which there was evidence to support the conclusion to which the Special Commissioners came, and that this being so it was not for the learned Judge, and indeed it was not properly open to him, to reverse their conclusion. In my view the learned Judge was wrong in disposing of the matter in that summary way. So far as the Special Commissioners themselves ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred. There is the case of Landes Brothers v. Simpson*, which is a decision of my brother Singleton as a Judge of first instance. There the appellants, who carried on business as fur and skin merchants and as agents, were appointed sole commission agents of a company for the sale in Britain and elsewhere of furs exported from Russia on the terms, inter alia, that they should advance to the company a part of the value of each consignment. All the transactions between the appellants and the company were conducted on a dollar basis and owing to fluctuations in the rate of exchange between the dates when advances in dollars were made by the appellants to the company against goods consigned and the dates when the appellants recouped themselves for the advances on the sales of the goods, a profit accrued to the appellants on the conversion of repaid advances into sterling. The decision was that the exchange profits arose directly in the course of the appellants' business with the company and formed part of the appellants' trading receipts for the purpose of computing their profits assessable to income-tax under Case I of Schedule D. My brother Singleton, on page 69 of the report, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able voluntarily, at its own free will, to sell those surplus dollars, if in that case the resulting profit should be regarded as income, whereas if the sale were a compulsory one the resulting profit would be capital. That is a distinction which, in my opinion, cannot possibly be made. To reduce the matter to its simplest elements, the appellant company has sold a surplus stock of dollars which it had acquired for the purpose of effecting a transaction on revenue account. If the transaction is regarded in that light, it seems to me it is precisely on all fours with the case of any trader who, having acquired commodities for the purpose of carrying out a contract, which falls under the head of revenue for purpose of assessment under Schedule D, Case I then finds that he has bought more than he ultimately needs and proceeds to sell the surplus. In that case it could not be suggested that the profits so made was anything but income. It had an income character impressed upon it from the very first. The other case bearing on the question of exchange profit, to which we were referred, was the case of McKinlay v. H.T. Jenkins and Son, Ltd.*, which I have already mentioned. Both parti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which is debited to that account, and the prices realised therefrom are credited, or it may result from realisation at a profit of assets forming part of the concern. In such a case a prudent man of business will no doubt debit to profit and loss the value of capital assets realised, and take credit only for the balance. But what was the nature of what the appellant here had to deal with? He had bought as part of the capital of the business his father's contracts. These enabled him to purchase coal from the colliery owners at what we were told was a very advantageous price, about fourteen shillings per ton. He was able to buy at this price because the right to do so was part of the assets of the business. Was it circulating capital? My Lords, it is not necessary to draw an exact line of demarcation between fixed and circulating capital. Since Adam Smith drew the distinction in the Second Book of his 'Wealth of Nations', which appears in the chapter on the Division of Stock, a distinction which has since become classical, economists have never been able to define much more precisely what the line of demarcation is, Adam Smith described fixed capital as what the owner tu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s a trading transaction or not. Sir Andrew Clark said (and with the reservation mentioned below I agree with him) that what was subsequently done with the deposits once they were received could not be material if their receipt was in origin properly to be regarded as a trading receipt. That he said must determine the character of the profit made by reason of their repayment in depreciated Chinese dollars. As regards the use in fact made of the deposits the matter stands thus: It is clear I think that under the terms of the deposit agreements the company was under no obligation to segregate the deposits from its other assets or earmark as between itself and the depositors and particular funds for the purpose of providing for the deposits. It was free to use the sums in question as it liked in its business in any way though it remained of course subject to the obligation of repaying these in the event of the agencies being brought to an end. As I have said, Sir Andrew Clark contends that that is an irrelevant consideration, and I agree with him, subject to this reservation: The company might conceivably have used these deposits in such a way as to mingle them with the capital e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is argument for the Crown, if I my say so, in his usual clear and attractive manner but he has not succeeded in convincing me that the Special Commissioners were wrong. He argues with force that this is an English company, trading in China; the results of its operations must ultimately be stated in terms of sterling. It does business in dollars and in particular receives these agency deposits in dollars. If as a result of those transactions it makes a profit through the difference in exchange between the sterling and Chinese dollars, why should that not be a profit of its trade? He says that the deposits received from agents were trading receipts giving rise to corresponding trade liabilities. He puts his argument as to that in effect in two ways: First, he says that you cannot regard each of those deposit transactions by itself as if it were a separate and isolated transaction. He says that it was the company's regular practice to conduct the bulk of its business through agents, of whom it employed no fewer than 600. He says that the appointment of agents was a common and customary operation in the course of the company's trading as the company chose to carry it on, and he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was the company's regular practice to appoint agents does not in my view invest the deposits taken from the agents with the character of trading receipts any more than the fact that it is the practice of a multiple trader to buy shops up and down the country whenever he sees fit to open a new branch invests his expenditure on such shops with the character of trade out- goings. Next , Sir Andrew Clark says, look at the character of the agent's deposit itself and the terms of the agreement under which it was made. He points out that on the face of the agreement the deposit was made to secure the due performance by the agent of his obligations; to secure, in other words, the due discharge of the liabilities which might arise from time to time from the agent to the company as a result of the agent carrying on business as agent for the company, selling the company's petroleum and so forth. Sir Andrew argued that a deposit so closely linked with the actual trading operations to be carried on by the agent must itself be regarded as a trading receipt. In that I venture to differ from him. If the agent's deposit had in truth been a payment in advance to be applied by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital. As appears from what I have said above, the evidence does not show that there was anything in the company's mode of dealing with the deposits when received to displace this prima facie conclusion. In my view, therefore, the conversion of the company's balances of Chinese dollars into sterling and the subsequent re-purchase of Chinese dollars at a lower rate, which enabled the company to pay off its agents' deposits at a smaller cost in sterling than the amount it had realised by converting the deposits into sterling, was not a trading profit, but is was simply the equivalent of an appreciation in a capital asset not forming part of the assets employed as circulating capital in the trade. That being so it was a profit of the nature not properly taxable under Schedule D, and the Special Commissioners in my view came to a right conclusion, which was rightly affirmed by the learned Judge, and I would therefore dismiss the appeal. COHEN, L.J.--I agree entirely with the conclusion and the reasoning which my brother Jenkins has given. I only desire to add a very few words about the decisions in the Landes case* and the Imperial Tobacco Company case**, on the pri ..... 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