TMI Blog1963 (7) TMI 78X X X X Extracts X X X X X X X X Extracts X X X X ..... 55) 1 The directors of the respondent were Leonard Lever, Leslie Levy and one Yablon, and the respondent carried on the business of a finance company. The memorandum of association of the respondent contained, inter alia, the following objects for which the respondent was established: To carry on the business or businesses of stock and share dealers, and to purchase, subscribe for, acquire, hold and deal in shares, stocks, debentures, bonds, securities and obligations generally of any government, company, corporation or body; and to promote, finance, advance money on hire-purchase or otherwise assist any company or companies, whether corporate or unincorporate, or persons as may be thought fit; and to act as agents for the issue and placing of, and to underwrite shares, debentures and other securities or obligations. The trading and profits and loss account of the respondent for the period September 1, 1954, to March 31, 1955, contained, inter alia, the following entries: To Purchases of Securities Quoted 166,208 5 0 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1,689,24 14 9 The figure of 1,317,565 for purchases of unquoted investments represented the cost to the respondent of the purchases of the entire share capital of three companies, i.e.: on December 10, 1954, B. Co. Wool Merchants (Bradford) Ltd. 175,075; on March 3, 1955, Cranwell (Holdings) Ltd. 732,823; and on March 25, 1955, N.E.T. Holdings Ltd. 409,667. To purchase those shares the respondent arranged overdraft facilities with its bankers who agreed to, and did in fact, lend it 93 per cent. of the value of the shares which were lodged with them by way of security. As additional security the bank also took a charge over the cash assets of those companies the whole of whose shares were acquired by the respondent. The assets of the three companies consisted almost entirely of liquid resources and each had substantial undistributed profits. The object of the directors of the respondent in purchasing these shares was to carry out an operation colloquially known as dividend stripping, that is to say, to transfer to the respondent by way of dividend the maximum amount of undistribut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n that the respondent was an investment company within the meaning of section 257(2) of the Income Tax Act, 1952, to which the provisions of section 245 of the Income Tax Act, 1952, applied, and that, therefore, the direction dated January 22, 1960, of the special commissioners was correct in law ; and that the appeal should be dismissed and the direction confirmed. The commissioners gave their decision in writing on March 20, 1961, in the following terms (so far as is material to the present case): The first question for our decision is therefore whether or not the company is an investment company. The company was incorporated in August, 1954, to carry on the business of a finance company, buying and selling stocks and shares, and this it did; and in our opinion having regard to the decision in the case of J.P. Harrison (Watford) Ltd. v. E.J. Griffiths** there can be little doubt that it was a trading company. The real question is whether it also falls within the definition of an investment company within the meaning of section 257(2) of the Income Tax Act, 1952. In the period covered by the aforementioned direction made by the special commissioners the company purchased, in p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the direction of the special commissioners is confirmed. The respondent appealed. Ungoed-Thomas J., allowing the appeal, held that as the primary object in this particular case was to obtain dividends in one swoop by dividend stripping, the operation was merely a means of turning shares into cash and profits as part of the respondent's trade in dealing in shares. The dividends, therefore, were not investment income but trading receipts, which should be included for computation in trading profits and charged as income under Schedule D within section 525 of the Act. In those circumstances the respondent was not an investment company and the direction of the commissioners should be discharged. The Crown appealed.. Sir Frank Soskice Q. C., Alan Orr Q. C.,E. B. Stamp and J. Raymond Phillips, for the Crown F. Heyworth Talbot Q. C. and H. Major Allen, for the respondent JUDGMENT F. Heyworth Talbot Q.C. and H. Major Allen for the respondent. The following cases, in addition to the cases referred to in the judgments, were cited in argument: Bradbury v. English Sewing Cotton Co.*; Canadian Eagle Oil Co. Ltd. v. The King; Edwards v. Bairstow; Gilbertson v. Fergu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he incorporation of a company and the withholding of dividends, passed legislation which in effect divided such companies into two categories-(1) trading companies and (2) companies which Parliament labelled investment companies. The trading company would continue to be liable to surtax on its profits only if it had failed to distribute a reasonable part thereof, having regard to its requirements for the maintenance and development of the business. The investment company, on the other hand, was to be subject to certain limitations in this respect. Then in 1939 it was enacted that an investment company should be liable to surtax on all its profits however much or however little it had distributed by way of dividend. This legislation has now been codified in the Income Tax Act of 1952. (See Chapter III thereof, comprising sections 245 to 264 inclusive.) In this field, therefore, it is advantageous to be a trading company and disadvantageous, as a rule, to be an investment company. The legislature originally defined an investment company by section 20 of the Finance Act, 1936. The like definition is now contained in section 257(2) of the Act of 1952. I had better quote it i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ividends to be paid to it by the three companies whose shares it had acquired, the total of such dividends being 927,408 after deduction of income tax at the standard rate, the equivalent gross amount being 1,686,198. The market value of the shares in the three companies naturally dropped as a result, and on March 31, 1955, their market value was estimated at 424,114, a figure which is not disputed. Since the company had bought them for 1,317,565, the difference was 893,451. The company claimed that this difference was a loss sustained in the trade of dealing in shares, and that under section 341 of the Income Tax Act of 1952 it was accordingly entitled to receive back from the Inland Revenue the income tax deducted at source from the dividends totalling 1,686,198 (gross) declared by its three subsidiary companies. The repayment would be limited under that section to a sum equivalent to income tax on a figure of 895,487, the alleged trading loss; that is, the aforesaid 893,451 plus a small loss on other stocks and shares. Even so, the tax reclaimed would amount to 404,020. The Inland Revenue admitted the claim and paid this sum. The cash receipts of the company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essed in the last mentioned decision*, dividends received under deduction of income tax by a trader in stocks and shares would form part of his trading receipts and thus enter into the computation of his trading profits, this of itself does not involve the consequence that the dividends thereby become charged under...Schedule D. For what is charged under that Schedule is the balance emerging when expenses have been put against receipts. For the company it is contended that pursuant to what was said in the Cenlon decision*, these dividends are trading receipts. They must, therefore, be brought into the computation of trading profits, albeit that some allowance will have to be made eventually for the tax suffered by deduction. Since they have to be brought into this computation they are charged under...Schedule D within the meaning of section 525(1)(c) of the Act of 1952. The Cenlon case* concerned what is colloquially known as a capital dividend ; that is, one paid out of non-taxable profits of the distributing company. The company could not, therefore, deduct income tax at source, and the recipient shareholder-that is, the Cenlon company-was not liable to income tax on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly involves an arithmetical exercise in which expenses will be set against receipts. Does this involve that the receipts are charged under...Schedule D ? Originally, at any rate, this was the root question in the case. Section 1 of the Income Tax Act, 1952, provides that where any Act enacts that income tax shall be charged for any year, then the tax shall be charged for that year in respect of all property, profits or gains respectively described or comprised in the Schedules. In relation to Schedule D, section 122 of the Act provides, so far as is here material, that tax shall be charged under Schedule D in respect of (a) the annual profits or gains arising or accruing-...(ii) to any person residing in the United Kingdom from any trade...whether carried on in the United Kingdom or elsewhere, and the wording of the charge concludes: in each case for every 20s. of the annual amount of the profits or gains. Section 127 enacts that tax shall be charged under Cases I and II of Schedule D on the full amount of the profits or gains... Case I, of course, is the Case under which trading profits are taxed. There are numerous other sections which follow, all using the expression ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment in the House of Lords as regards the War Loan interest, but maintained it as regards the interest on the other securities. The House rejected it, on the ground that exemption from tax meant what it said, and that even as a component part of the profits of a trade all the interest was exempt. It does not, in my judgment, necessarily follow from this decision that in the opinion of the House of Lords the interest, regarded as gross receipts of the company's trade, was charged under Schedule D and escaped tax by reason only of the exemption. The House did not need to decide that question one way or the other. On the view they took it was enough to say that the interest was exempt from all taxation, and it did not matter how it was charged. In the Cenlon case a similar argument was raised. It was said This dividend is not charged to tax. If it is treated as part of the profits of the trade, it will be taxed, and thus the freedom from tax will be lost. This is contrary to the decision in Hughes v. Bank of New Zealand. Again the argument did not succeed. Nothing in that case, in my opinion, compels us to the conclusion that the dividends in the present case must be taken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot regard dividends as a new income for income tax purposes, but simply as part of a fund which has already been charged to income tax in the hands of the company paying the dividend. Thus it is right to say that the dividends here in question have been charged to tax under Schedule D and the definition of earned income in section 525 is so far satisfied. This is an engaging argument, but I do not think it is right. The reason suggested why dividends are liable to surtax may be sound enough, but we have to get back to the meaning of the words charged under Schedule D appearing in section 525. There is nothing in that section, in my opinion, which justifies tracing back the history of a dividend until one can find it forming part of trading profits. How far back would one be entitled to go? There might be one or more holding companies interposed between the trading company and the individual who ultimately receives, via the holding companies, a share of the trading company's profits, but no machinery is provided for finding this out, or dealing with such a situation. Then again, the words of section 525 defining earned income include the words and is immediately deriv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Only if the last sentence means that in the judge's view gross receipts of a trade are charged merely by being brought into the computation of trading profit, would I venture with respect to disagree. On this aspect of the case attention may usefully be drawn to certain provisions in Chapter III of Part IX of the Act of 1952. Section 245 refers to a company which has not distributed a reasonable part of its actual income from all sources... Section 250 requires a company on request by the special commissioners to deliver to them, inter alia, a statement of the actual income of the company from all sources... Section 255(3) requires that such income shall be estimated in accordance with the provisions of this Act relating to the computation of income from that source... In F.P.H. Finance Trust Ltd. v. Inland Revenue Commissioners (No. 2)* the House of Lords, construing the expression now reproduced in section 257(2), namely, a company the income whereof consists mainly of investment income, held that the words the income whereof meant the actual income from all sources computed as for income tax ; and in the recent case of C.H.W. Huddersfield Ltd. v. Inlan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ks and shares. On this latter point his decision was subsequently reversed. Nevertheless, the point could have been taken before Ungoed-Thomas J. who heard the case on three days in the latter part of November, 1962, and gave judgment on December 7, 1962. A certain hesitation on the part of the company to take the point is understandable. It had represented to the revenue that for the period in question it had made not a trading profit of 800,000, but a trading loss of 895,000, and on that footing had recovered from the public purse a sum of no less than 404,020. The present point involves the company in contending that this was all wrong, and that under the repayment section of the Income Tax Act, 1952 (section 341), which it had invoked, nothing was repayable to the company at all. Before us, the Crown raised no question of estoppel, nor did it object to this point now being raised. In all the circumstances the court decided to admit it, treating the argument simply as another facet of the company's contention that it had no investment income. The answer given to the point by Sir Frank Soskice was this. Conceding that upon a true view of the relevant law the com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rt the Crown's contention in the present case that one must first ascertain the total income of the company and then, even if that total income be found to consist entirely of trading profit, go on to analyse that trading profit to see whether dividends contributed towards it and, if so, in what measure. The House of Lords was not considering that point at all, and indeed would not allow the point to be taken in the House for the first time that the dividends were trading receipts. The situation before the House was, therefore, simply the case of a company with a trading loss but also with income from investments, that income not being treated as trading income. I cannot, as I say, find support for the Crown's present contention in that decision. So far as the intrinsic merits of the argument are concerned, of course it follows from section 257(2) that once you have found what the total income of the company is, you must find out whether that total income consists to any, and, if so, to what, extent, of investment income. For example, if one finds that a company has both trading profit and income from investments comprised in its total income, one must sort out the inv ..... X X X X Extracts X X X X X X X X Extracts X X X X
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