9911796707
TMI Blog1964 (6) TMI 56X X X X Extracts X X X X X X X X Extracts X X X X ..... 1955, should be deemed to be the income of the respondent's members was confirmed; and the effect of the order of the Chancery Division (affirmed by the Court of Appeal) was to discharge the direction which had been made upon the footing that the respondent was an "investment company" within the meaning of section 257 of the Act of 1952. The question in issue in this appeal was whether the respondent was for the period in question an investment company within the meaning of section 257, it being common ground that the validity or otherwise of the direction made upon the respondent depended on the answer to that question. The following facts were found by the special commissioners in the case stated. The respondent was incorporated on August 19, 1954, with a share capital of £ 100 divided into 100 shares of £ 1 each, which were held as follows during the relevant period: Leonard Lever and his wife May Lever as trustees (as from October 19, 1954) 38 Leslie Lavy and his wife Rita Lavy as trustees (as from January 18, 1955) 15 J.H. Howard (transferred to Mr. and Mrs. Lever, February 4, 1955) 1 J.D. Collinson (transferred to Mr. and Mrs. Lever, Febru ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... antial undistributed profits. The object of the directors of the respondent in purchasing those 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 the undistributed profits of the companies and then to use the resulting fall in the value of their shares as the basis of a loss claim under section 341 of the Income Tax Act, 1952, so as to reclaim the tax deducted or deemed to have been deducted from the dividends declared and paid to the respondent. Those operations were duly carried out by the respondent for each of the three companies mentioned above, and the dividends paid to the respondent on March 28, 1955, were as follows: B.&Co. Wool Merchants (Bradford) Ltd. £ 33,523 (net); Cranwell (Holdings) Ltd. £ 494,629; N.E.T. Holdings Ltd. £ 399,256, making a total of £ 927,408 (net), 1,686,198 (gross). The shares of the three "stripped" companies were retained by the respondent for any ultimate purpose that the directors could put them to, their market value at March 31, 1955, being estimated as follows: B.&Co. Wool Merchants ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rison (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 particular, the share capital of three companies with the object of carrying out what has been called a 'dividend stripping' operation in each case. The result of these operations was that the company's accounts made up to March 31, 1955, showed a gross trading loss on the one hand amounting to £ 895,487 and dividends received from quoted securities £ 3,043 and unquoted securities £ 1,686,198-a total of £ 1,689,241-on the other. The company made a claim under section 341 of the Income Tax Act, 1952, which was duly admitted, for repayment in respect of the tax deducted from these dividends in relation to the trading loss. It is said that, although it was quite proper to compute the trading loss of the company for the purposes of Schedule D without including the dividends received by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Appeal (Sellers, Donovan and Russell L.JJ.). This was an appeal by the appellants, the Commissioners of Inland Revenue, from an order of the Court of Appeal (Sellers, Donovan and Russell L.JJ.) dated July 18, 1963, affirming an order of the Chancery Division of the High Court of Justice (Ungoed-Thomas J.) whereby an appeal by the respondent, F. S. Securities Ltd., by way of case stated from a determination of the Commissioners for the Special Purposes of the Income Tax Acts made on March 20, 1961, was allowed. By the determination of the commissioners a surtax direction made by the (Assessing) Special Commissioners, pursuant to section 245 of the Income Tax Act, 1952, directing that for the purposes of assessment to surtax the actual income of the respondent from all sources for the period from September 1, 1954, to March 31, 1955, should be deemed to be the income of the respondent's members was confirmed ; and the effect of the order of the Chancery Division (affirmed by the Court of Appeal) was to discharge the direction which had been made upon the footing that the respondent was an " investment company " within-the meaning of section 257 of the Act of 1952. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ents 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 those 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 the undistributed profits of the companies and then to use the resulting fall in the value of their shares as the basis of a loss claim under section 341 of the Incom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 particular, the share capital of three companies with the object of carrying out what has been called a 'dividend stripping' o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. On appeal, the Court of Appeal affirmed that decision. The Crown appealed. Alan Orr Q.C., E.B. Stamp and J. Raymond Phillips for the appellants. This appeal arises under a surtax direction made by the (Assessing) Special Commissioners in respect of the respondent company's income. The question is whether the company was an investment company in the period in question. Section 257(2) of the Income Tax Act, 1952, defines an "investment company" as "a company the income whereof consists mainly of investment income," and it defines "investment income" as "income which, if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Finance Act, 1937, in directing that the amount of a loss sustained in a trade should in all cases be computed in like manner as the profits or gains arising or accruing from the trade were computed under the rules applicable to Case I, was designed to put an end to this practice and shows that the legislature had expressly or impliedly approved the exclusion of dividends taxed at source from the computation required for the purpose of ascertaining the profits or gains of a trade. The practice of excluding from Case I interest or dividends which had suffered tax by deduction was also impliedly recognised and approved by the legislature in rule 15(2) of the Rules applicable to Cases I and II of Schedule D in the Income Tax Act, 1918, and in section 27 of the Finance Act, 1938, section 22(2) of the Finance (No. 2) Act, 1945, section 18(3) of the Finance Act, 1954, and section 4 of the Finance (No. 2) Act, 1955. The rule that dividends having once suffered tax by deduction cannot be taxed again by being brought into a computation of profits or gains for the purposes of Case I is to be deduced from the statutory provisions themselves: see per Lord Phillimore in Bradbury v. En ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ling in stocks and shares. When these are brought into the computation of the profits of the trade the result is to produce a trading profit. This profit is the only income of the company and since it is entirely trading income, the company does not come within the definition of "investment company" contained in section 257(2) of the Income Tax Act, 1952. The case for the respondent company is put as follows: (1) The sole income of the company for the period concerned was its trading income and this trading income was income which, if the company were an individual, would be "earned income." (2) The dividends from the three stripped companies were dividends on shares held as part of the company's trading stock, were part of the company's trading receipts and, as such, were to be taken into account in determining the company's trading profits. (3) The company had no "investment income," or other income apart from its trading profits. (4) It is not permissible to dissect the company's trading profits and to examine the company's trading receipts to see if any of those receipts could, if considered separately, be regarded as "inv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 52, for "repayment" of tax, and repayments were made in due course amounting in all to ? 404,020. It is found as a fact in the case stated that the object of the respondent in purchasing these shares was to carry out an operation colloquially known as "dividend stripping." All this was done in accordance with the practice which prevailed before Parliament took action to stop this kind of operation. The present case has arisen out of a direction given by the special commissioners in 1960 on the footing that the respondent company was an investment company within the meaning of section 257(2) of the Act of 1952. This direction was to the effect that the income of the respondent company should be deemed to be the income of its members. The respondent appealed on the ground that it was not an investment company. The special commissioners held that it was, and stated a case. The respondent succeeded before Ungoed-Thomas J. and the Court of Appeal, and the Crown now appeal to this House. Section 257(2) provides that "'investment company' means a company the income whereof consists mainly of investment income, and 'investment income' means, in re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... out of profits under deduction of tax. Why is the shareholder not taxed on what he receives? It is part of his income, or if he is a trader it is a trading receipt. But it seems always to have been recognised that an individual does not pay income tax on it (I do not refer to surtax), and a trader does not include it as a trading receipt in determining his taxable profits." But the view of Lord Simonds and, to some extent, that of Lord Denning were different. In the ordinary case it would make no practical difference which view is right, but in this case if Lord Simonds' view were right it would support the respondent's argument. He said*: "I would affirm what was said by Donovan L.J. (than whom no one has a wider knowledge of revenue law) about the treatment by a trading company of dividends from which tax has been deducted at the source. There is no doubt that the practice is and, so far as I know, always has been to include such dividends in the computation of profits taxable under Case I of Schedule D, and to make an allowance or adjustment for the tax that has been paid." I do not think that Donovan L.J. went quite so far as that, because he does not s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he receives the dividend. That would reduce the tax payable under Schedule D to ? 2,000, but there is no statutory warrant whatever for making that deduction. If the appellants' view is right the proper procedure is much simpler. In the case I have supposed, the trader would simply leave the dividends out of his profit and loss account, which would then show a profit of ? 4,000 and he would pay ? 2,000 on that profit, so if there is a profit apart from the dividends it makes no difference which view is adopted. But it does make a difference if, apart from the dividends, the trader's operations show a loss. How great a difference that can be is shown by the present case. Your Lordships must now choose between those two methods without any authoritative guidance. I have no hesitation in preferring the appellants' method, for a number of reasons. In the first place, it is in accord with long standing practice and it has never been challenged: the matter was only considered incidentally in the Cenlon case*, and I do not think that it was the subject of any detailed argument. Secondly, it is much simpler and more direct. Thirdly, it avoids the fiction of having to regard ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from all sources for the period September 1, 1954, to March 31, 1955, should be deemed to be the income of its members, is a valid direction; if it is not, the direction is made on a wrong basis. It suits the respondent, or at any rate it suits its members, to maintain at this stage that in the period in question its income is to be regarded as that of a trading company. The definition of an "investment company" is provided by the statute and it is made for the purpose of implementing the part of it that deals with surtax directions. By section 257(2) an "investment company" is declared to be one the income of which consists mainly of investment income, and "investment income" is income which, if the company were an individual, would not be earned income. It is not necessary to pause here upon the general question whether a financier, such as the respondent is, would ordinarily be regarded as earning the dividends which may be declared upon the shares held by him for the purpose of his profit making operations, for by section 525 of the Act "earned income" is defined as being "any income which is charged under Schedule B or Schedule D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dent by two payments, one in December, 1955, and the other in February, 1958. The argument on which the respondent relies in its opposition to the surtax direction that has been served upon it is in direct conflict with this course of proceeding. What it now maintains is that, as a trader in stocks and shares, it had no income during the relevant period that was not properly assessable under Case I of Schedule D as the profit of its trade. This would mean that the interest and dividends which it received, which are, to put it neutrally, the income yield on its investments, ought to be treated as mere items to the credit of its trading account and entered there accordingly; with the result that all its receipts were trading receipts and the "raw material" for a Case I assessment. From this it follows, it is said, that there was no investment income at all within the meaning of the Act and the direction received was illegal. Even if I accepted the argument itself, which I certainly do not, I am far from thinking that I should necessarily accept the conclusion. It seems to me that, if a taxpayer chooses to set out to prove that the Income Tax code is so constructed as to p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... system and the peculiarities that it engenders. But that point is not material for the present purpose. What is material is to find out whether the theoretical method of composing the trading account, which I have just supposed, can possibly be adhered to, so far as interest and dividends are concerned, when the same individual has to strike the balance of his profits or gains for assessment under Case I of Schedule D to the Income Tax Act. This inquiry cannot be conducted without restating the position of dividends as a subject of charge to income tax. I think that in this case one can confine oneself to dividends since it is the dividends of the three "stripped" companies that are the substance of the matter, but it has also to be noticed that some of the receipts which, it is said, ought to be included in the Case I assessment were interest on British Government securities from which the paying agent had deducted income tax on payment, as required by Schedule C. Theoretically, I agree, there is no difference between the argument for including such interest and the argument for including dividends which are not dealt with by that Schedule. It is only that in practice ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion between any particular fund of profits and a dividend paid has now become in effect untraceable and the rule that the company recoups itself at the standard rate of tax that is current at the date of payment means that company and shareholder do not necessarily equate their respective positions as completely as the theory of the matter would require. If, then, the dividends here in question have borne tax in the hands of the paying company and if they were therefore "franked income" in the hands of the respondent as receiving shareholder, does the income tax code authorise the revenue to enter them as a receipt in its trading account for the purpose of assessing it to tax on a separate taxable subject, that is, the trading profit? To my mind, to allow it to do so would be to recognise double taxation in its most obvious form: not the less so, as I see it, because on the one side dividends are taxed as an aliquot share of a fund of profit and on the other they would be brought in as "mere" contributors to establish the balance of the trading profit of the individual recipient. But double taxation in itself is not something which it is beyond the power of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n does not deal with the propriety or otherwise of such a method of estimating assessable profits, but there does not seem to have been any dispute about it. Nor, it would appear, have there been doubts or disputes since, prior to the observations made in the Cenlon case**. Indeed, the practice of excluding dividends from assessments of trading profits (or losses) has been not only recognised in more than one Income Tax or Finance Act but has actually been incorporated in the structure of loss reliefs set up for the administration of the tax. I ought to add at this point that, as far as I can see, the principle for which the respondent contends cannot be confined to the ascertainment of the profits of a finance or stock dealing concern and should just as well govern the assessment of the profits of many other kinds of trading concerns, such as banks and insurance and assurance companies and commercial and industrial firms who employ part of the capital of their business in invested reserves. However that may be, rule 15(2) of the Rules applicable to Cases I and II of Schedule D in the Income Tax Act, 1918, assumed that, failing specific statutory direction, the correct form of ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to include in the Schedule D assessment had borne its appropriate tax under another Schedule, Schedule A or Schedule C. Does it make any difference in the application of the principle that dividends that have suffered deduction of tax cannot be said to be taxed under a different Schedule but are either taxed under the same Schedule (if you think of them as the residue of a taxed fund of trading profit) or under the general provisions of the tax code (which allows the company to pass on to shareholders by way of deduction and recoupment the tax that its own profits have borne)? I think that it makes no difference at all. It only throws up in the more marked form the grossness of the double taxation, if the dividends are regarded as taxable twice over under the same Schedule, once by virtue of the shareholder's participation in the company's trading profit and once by virtue of his own trading profit being augmented by the fruits of that participation. It is common ground, I think, that the Court of Appeal's decision in this case can only be supported if certain expressions of opinion which appeared in the judgments of that court and the speeches in this House in the Ce ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... I am quite unable to see where it comes from. It seems to me merely an illegitimate way of trying to mitigate the consequences of a wrong principle. It is one thing to say that the Income Tax Acts, properly interpreted, do not allow the introduction of taxed dividends into assessable trading accounts. Then the tax system works as it is intended to. To take the figures of the present case, there is a loss on trading of ? 895,487, which section 341 allows to be set off against the taxed dividend income of ? 1,686,198. That gives a return of ? 404,020 by way of tax reclaimed. But if, on the other hand, the Income Tax Acts are held to require the dividends, though they have borne tax, to be written into the trading account, then there is a profit on that account of ? 800,000 and no trading loss. In that situation Parliament has granted tax on the full amount of the dividend income and also on the balance of the trading profit. What is there to prevent the revenue from collecting the full tax that is due or to allow it not to collect what it ought? There is no claim for loss relief, because there is no loss; and, so far as I am aware, there is no power in a court of law to restrain the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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