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TMI Blog1963 (7) TMI 78X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Unquoted 1,317,565 1 7 1,483,773 6 7 1,483,773 6 7 To gross loss brought down 895,487 8 3 By Sales of Securities 135,357 0 0 Securities on hand-March 31, 1955 Quoted 28,814 10 6 Unquoted 424,11 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14. In due course the respondent made a claim for repayment of tax under the provisions of section 341 of the Income Tax Act, 1952, which was admitted in the sum of £ 404,020, of which £ 250,000 was repaid on December 14, 1955, and £ 154,020 on February 28, 1958. On January 22, 1960, the special commissioners issued a direction to the respondent in the following terms: "Whereas it appears to the Special Commissioners of Income Tax that F.S. Securities Ltd. (formerly Federated Securities Ltd.) is an investment company to which section 245 of the Income Tax Act, 1952, applies, the Special Commissioners of Income Tax hereby give notice that they direct that for purposes of assessment to surtax, the actual income of the said company from all sources for the period from September 1, 1954, to March 31, 1955, shall be deemed to be the income of the members and the amount thereof shall be apportioned among the members..." It was contended on behalf of the respondent that the respondent was not 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e provided in section 525(1)(c), i.e., they were 'income which is charged under Schedule B or Schedule D and is immediately derived...from the carrying on or exercise of (the company's) trade.' If this were correct the company would not fall within the definition of investment company in section 257(2)...We do not think that this argument is well founded. On the authorities cited to us, in particular Hughes v. Bank of New Zealand*** and Cenlon Finance Co. Ltd. v. Ellwood#, it seems to us that dividends cannot be charged to tax under Schedule B or Schedule D and cannot, therefore, be regarded as earned income within the terms of the definition contained in section 525(1)(c). Moreover, the company's primary object in purchasing the shares in the three companies subjected to the 'dividend stripping' operation was to obtain the dividends, i.e., the income arising from the shares, and not to deal in the shares themselves, which could only have been sold at a loss after the operations had been carried out and which in fact were never sold or otherwise disposed of. It seems to us that in these circumstances apart from the question of law to which we have already re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e a fabulous profit on £100 subscribed capital. If the facts are to be accepted as establishing a "trading" or any loss, a more fictitious or home-made loss it would be hard to devise in business affairs. As the shares of the three companies which F. S. Securities Ltd. acquired and with which they traded were their stock-in-trade producing trade earnings, the same shares were not a separate source producing an investment income and without that income being established as investment income the respondent company cannot be held to be an investment company, however desirable it would be that such transactions as were carried out by or on behalf of the few members of the company should make their contribution, by means of taxation, to the requirements of the country's revenue. Enrichment without any service to the community and without taxation is hard to countenance. DONOVAN L.J. This is an appeal by the Commissioners of Inland Revenue from a decision of Ungoed-Thomas J. given in favour of the tax- payer, F.S. Securities Ltd. Against that company the Special Commissioners of Income Tax had made a direction under the provisions of the Income Tax Acts dealing wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arguing that it was a trading company and not an investment company. This argument failed before the special commissioners but succeeded before Ungoed-Thomas J. The court is here concerned with a dividend stripping operation. The company was incorporated on August 19, 1954, with a capital of £100 and 83 per cent. of the capital was held by two persons jointly. The memorandum of association proclaimed that one of the objects of the company was to carry on the business of stock and share dealers. On December 10, 1954, the company purchased the entire share capital of B. & Co., Wool Merchants (Bradford) Ltd. On March 3, 1955, it purchased the entire share capital of Cranwell (Holdings) Ltd. and on March 25, 1955, the entire shareholding of N.E.T. Holdings Ltd. These purchases cost altogether £ 1,317,565 and one might well ask where this £ 100 company got the money from. The answer is that as to 93 per cent. of it, it came from the company's bankers on loan. These three companies were, as the saying goes, "full of dividend"that is, of undistributed profit represented by liquid resources-and the advantage of these purchases to their shareholders was tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... This depends on whether its income during this period was mainly "investment income" and this depends in turn on whether its income was mainly income which, had the company been an individual, would not have been earned income. Earned income is defined by section 525 of the Income Tax Act of 1952, and the part of that definition here relevant is that contained in section 525(1)(c), namely: "any income which is charged under Schedule B or Schedule D and is immediately derived by the individual from the carrying on or exercise by him of his trade..." One has to assume, therefore, that the company is an individual, and an individual trading in stocks and shares. On that assumption the question is whether these dividends totalling £ 1,686,198 gross were income charged under Schedule B or Schedule D, and were they immediately derived from the carrying on of a trade? If so, they will be earned income and the company will not be an investment company. If not they will not be earned income and the company will be an investment company. The argument on this narrow question of construction has travelled over a wide field, but I need do no more than summarise it. F ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e ought to be brought into such a computation. Strictly speaking, of course, this was obiter, but it would have been unsatisfactory not to deal with the point thus raised. In the House of Lords(8) Viscount Simonds and Lord Denning expressed the same view: and accordingly even if, on reflection, I thought I had been mistaken in what I myself said in this court, I would certainly defer to their view. But I see no reason to depart from what I said. Viscount Simonds did say***, however, that it had always been the practice of the revenue to include taxed dividends in the computation of a share dealer's profits for the purpose of assessment. This apparently was not so: Rex v. Commissioners of Income Tax for the City of London, Ex parte Inland Revenue Commissioners*. This would not be the first time, however, where revenue practice and the law parted company. I say this in no spirit of criticism. This is a difficult code to administer, and practical considerations no doubt justify at times some departure from strict law for the common convenience of the revenue and the taxpayer. In my opinion one must take it to be the case that in law the dividends taxed at source with which we are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessment under that case" this is, Case 1; and section 4 of the Finance (No. 2) Act, 1955, the provision which ended the attraction of dividend-stripping, enacts, in sub-section*, so far as is here material, "the net amount of the dividend received on the shares...shall...be brought into account in computing the profits or gains or losses of the trade..." So far, therefore, there seems to be no support for the view that trading receipts as such are "charged under... Schedule D." Mr. Talbot, however, contends that if it were not so, then the decision in the House of Lords in Hughes v. Bank of New Zealand* would have had to be the opposite of what it was. The Bank of New Zealand was a non-resident company carrying on business at a branch office in London. As part of the assets of that branch it held some 5 per cent. War Loan and some India Government stock, securities of the Grand Pacific Railway and securities of the Auckland Electric Power Board, and on these various holdings it received interest. The War Loan had been issued by the Treasury with a condition that the interest should be exempt from all taxation in the hands of a beneficial holder not ord ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unless crucial omission or clear direction makes that end unattainable. Now, there are three stages in the imposition of a tax: there is the declaration of liability, that is the part of the statute which determines what persons in respect of what property are liable. Next there is the assessment. Liability does not depend upon assessment. That, ex hypothesi, has already been fixed. But assessment particulars the exact sum which a person taxed does not voluntarily pay." I am afraid I do not see how this passage helps in the present case. The declaration of liability we have to consider is that made by the statute in the shape of Schedule D. The question is, however, on what is liability imposed, and that it seems to me must be decided by construing the language of the Act, and in particular Schedule D itself. A further argument by Mr. Talbot which he submitted as an alternative was this. He began by posing the question: "Why are dividends in the hands of an individual liable to surtax at all as part of his total income?" and the answer he gave was this. Income tax is levied by section 1 of the Act on profits and gains arising under the specified Schedules. The same ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company whose income consisted of dividends from a fund of profits charged in some other company's hands under Schedule C. The latter company would be an investment company while the former would not, a distinction for which there would be no rhyme or reason. Accordingly I reject this alternative argument. I should add that in any event the court does not know that the dividends now being considered came out of trading profits taxed under Schedule D in the hands of the three subsidiary companies or any of them. There is no finding in the case one way or the other. Mr. Major Allen also submitted, for additional reasons, that the word "charged under Schedule D" ought to be regarded as satisfied in the case of dividends, if those dividends were derived from shares in a trading company and were a distribution of its trading profits. I have already given my reasons for taking a contrary view, and need not repeat them. So far my conclusion would be that looking at these dividends by themselves it could not be said that they were charged under Schedule D; that they were therefore not earned income; that consequently under section 257(2) of the Act they were "investment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... these observations support the views I have so far expressed. At the end of the argument for the respondent, however, Mr. Major Allen raised another point. Consistently with the decision in the Cenlon case##, all the dividends received by the company in the period under consideration must, he said, be considered as part of the receipts of the company's trade in dealing in stocks and shares. When these are brought into the computation of the profits of that trade, the result is to produce a trading profit. The figures are: dividends received from quoted securities, £ 3,043; from unquoted securities (that is, the "stripped" shares), £ 1,686,198; totalling £ 1,689,241. Deduct the trading loss of £ 895,487, and the balance of profit is £ 793,754. That figure, which I will call a round £ 800,000, is the figure of profit from the company's trading and is the only income of the company. Since it is entirely trading income the company cannot be an investment company within the statutory definition. There is no trace of any such contention as this in the stated case, and we were informed that the point was not taken, either before the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... speech in F.P.H. Finance Trust Ltd. v. Inland Revenue Commissioners (No. 2)**. As I have said, section 257(2) defines an investment company as a company "the income whereof consists mainly of investment income...", and the Crown here argues that the word "consists" justifies the dissection or analysis of the company's trading profit to find out whether it "consists" to any extent of investment income. In F.P.H. Finance Trust Ltd. v. Inland Revenue Commissioners (No. 2)* the House of Lords decided that the words "the income whereof" appearing in the provision which was the predecessor of section 257(2), meant the total income of the company from all sources, and it was with that total income that such part of it as consisted of investment income had to be compared, to see whether the company was an investment company. For the period in question F.P.H. Finance Ltd., a company trading in stocks and shares before it went into liquidation on April 1, 1938, had made a trading loss, but this loss was, conformably with the practice then obtaining, calculated without taking into account dividends received. Curiously enough, before the House of Lo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordance with the Cenlon decision* was, as I say, £ 800,000 and this was its total income. That being so, the company cannot be an investment company, unless it is permissible to dissect that admitted trading income to see whether it has been computed by including dividends as trading receipts, and then treating such receipts to that extent as "investment income." Such dividends have become part of the trading profit which is "earned income" within the definition contained in section 257(2). They are not, for the purposes of the inquiry, one thing one moment and another thing the next. To my mind this new point allowed to be taken by the company is conclusive of the appeal in its favour. In the concluding part of their decision the commissioners refer to the company's primary object in purchasing the shares in the three "stripped" companies as being to obtain the dividends and not to deal in the shares themselves, which would thereafter only be sold at a loss and which in fact have so far been retained. The commissioners go on to say that in those circumstances the nature of the income from the shares "is more akin to investment income t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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