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TMI Blog1957 (4) TMI 1X X X X Extracts X X X X X X X X Extracts X X X X ..... on to a specified voyage or event. To take the most important of them, fire insurance policies, they are issued normally for one year, and the whole of the premium due thereon is received when the policies are actually issued. In any given year, while the premiums due on the policies would have been received in full, the risks covered by them would have run only in part and a part will be outstanding for the next year. The companies have to prepare annual statements of profit and loss for the purpose of ascertaining their profits and distributing their dividends. They have also to prepare revenue statements to be sent to the authorities under the provisions of the Insurance Act, 1938. The method adopted by the respondent in preparing the above statements has been that while the premiums received are all of them included in the assets of the year, a certain proportion thereof, usually 40 per cent., is treated as the reserve for unexpired risks, and that is shown as a liability. To take a concrete example, if in the year 1939, the respondent issued annual fire insurance policies and received a sum of Rs. 1,00,000 as premiums thereof, the whole of it would be shown as income in the st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under the second proviso thereto they have to be calculated " by applying the statutory percentage to the average amount of capital employed in the business during such chargeable accounting period. " Schedule II enacts rules for the determination of the average capital employed. Under rule 1(c), the capital employed will include the value of all assets " when they became assets of the business ". Rule 2(1) enacts that any borrowed money and debts shall be deducted from out of the value of the assets. There is a further provision in rule 2(1), which is what is material for the purpose of the present appeal, and it runs as follows : " The debts to be deducted under this sub-rule shall include any such sums in respect of accruing liabilities as are allowable as a deduction in computing profits for the purposes of excess profits tax ............. and the said sums shall be deducted notwithstanding that they have not become payable." For this clause to apply two conditions must be satisfied. The sums to be deducted should be allowable as a deduction in computing the profits for the purpose of the Act, and further they should be in respect of accruing liabilities. Rule 1 of Schedul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s a certain amount as the value of that liability, it is a sum in respect of an accruing liability and must be deducted under rule 2. In support of this contention, the decision in Sun Insurance Office v. Clark was relied on. The facts of that case were as follows : A fire insurance company which had been following the practice of entering in its annual statements 40 per cent. of the total premium receipts as reserve for unexpired risks claimed a deduction therefor in the assessment of its annual profits. The validity of the claim having been disputed, the question as to its admissibility was referred to the decision of the Court. Bray, J., who heard the reference, held that the amounts reserved for unexpired risks should be deducted firstly on the ground that the premium which had been paid in respect of a risk for a whole year could not be said to have been wholly earned, when a portion of the period covered by the policy was still to run, and that the reserve therefore was not income earned, and secondly and in the alternative, on the ground that as the premium had been received burdened with a liability which had been only partially discharged in the year of account, the port ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ink the description ' unearned premium ' which has been used to describe this latter portion is a very appropriate and accurate description." It is also material to note that one of the authorities relied on for the Crown was the decision in Scottish Union and National Insurance Company v. Smiles wherein, discussing how the reserve for unexpired risk in fire policies is to be dealt with in computing the profits, the Lord President observed : " Seeing that fire insurance policies are contracts for one year only, the premiums received for the year of assessment, or on an average of three years, deducting losses by fire during the same period and ordinary expenses, may be fairly taken as profits and gains of the company without taking into account or making any allowance for the balance of annual risks unexpired at the end of the financial year of the company." Referring to this and to another decision, Lord Haldane observed that they " are not, when carefully examined in the light of what appears to be the true principle, reliable as authorities for the proposition which would run counter to the practice and good sense of the commercial community." On the strength of the obse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payable or will become payable in the future by reason of a present obligation, debitum in presenti, solvendum in futuro. An accruing debt, therefore, is a debt not yet actually payable, but a debt which is represented by an existing obligation." Israelson v. Dawson (Port of Manchester Insurance Co. Ltd., Garnishees), was again a decision on Order XLV, rule 2, the Court holding that the amount which became payable under a policy as the result of the accident specified therein having occurred was, nevertheless, not a debt which could be attached under this rule, before the compensation had been determined by the arbitrator in accordance with the conditions of the policy. The argument of the respondent based on the above decisions is that until the risk specified in the policy materialises and consequent thereon, the compensation payable thereunder is ascertained, there is only a contingent liability and not a debt, and that such liability is not within rule 2 of Schedule II to the Act. In answer, the learned Solicitor-General contends that the decisions quoted above are not in point, they having been given on a different statute, that the decision in Sun Insurance Office v. Clar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons, which are pertinent to the present discussion : " Reliance was placed, during the argument, on Sun Insurance Office v. Clark, in which this House held that a percentage of the premium income of an insurance company might be deferred as a receipt to a future year because it was paid as consideration for future liability, but the principle of that decision is not, in my opinion, applicable to the present case. The premium income was only deferred and would suffer tax in a future year, whereas, in the present case, if the appellant is permitted to deduct compensation, which it has not paid and which it may never have to pay, that compensation will escape tax altogether. There is, in my opinion, a fundamental distinction between a contingent liability and a payment dependent on a contingency. When a debt is not paid at the time it is incurred its payment is, of course, contingent on the solvency of the debtor but the liability is not contingent. Similarly, the liability in Sun Insurance Co. v. Clark, was not, in my opinion, contingent but remained in force throughout the period of the insurance, though payment in pursuance of that liability might, or might not, have to be made." ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... important and arduous tasks in the ascertainment of taxable profits under the Act. Rule 1 of Schedule II to the Act enumerates three categories of properties, which are to be included in the computation of capital. It is to be noted that this rule does not adopt any legalistic or conventional, notion of what is technically termed " capital "; but it proceeds on a factual basis to include whatever is utilised in business, whether it be tangible property or intangible property. The object of this provision is clearly to confer a benefit on the assessee by enabling him to retain at least in part the profits realised by him by investment of additional capital. Then there is rule 2, which provides for certain deductions being made out of capital. Omitting for the present " accruing liabilities ", which form the subject of the present controversy, the other two items mentioned therein are borrowed money and debts, and the reasons for their exclusion from capital falling within rule 1 would appear to be this : money borrowed and debts incurred for the purpose of the business must have been utilised in it, and would be included in the capital employed as defined in rule 1. The policy of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Income-tax Act, what is allowed as a deduction is any liability incurred solely and exclusively for the purpose of the business, and when that has not matured, its value is to be determined according to rules of accountancy and deducted. But when a deduction is claimed under rule 2, what has to be seen is whether the obligation is such that it could be regarded as an asset used in the business, such as could conceivably contribute to its profits. If, that is not established, then it cannot be included as capital under rule 1, and cannot be deducted therefrom under rule 2 as an accruing liability. It should not be overlooked that a deduction under section 10 of the Income-tax Act and that under rule 2 of Schedule II to the Act proceed on totally different lines and have different objects in view. Under section 10, the deduction is claimed by the assessee, and that has the effect, when allowed, of reducing the taxable profits. Under rule 2, it is claimed by the Department, and if allowed, it will enhance the liability of the assessee by reducing the capital under rule 1. Incidentally, how inappropriate the principle laid down in Sun Insurance Office v. Clark would be if it is applie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Revenue Commissioners. There, the question arose whether a conditional liability under a contract was an " accruing liability " within the corresponding provision in the English Excess Profits Tax Act. The facts were that on 16th December, 1939, all agreement was entered into between the Ministry of Aircraft Production and a company engaged in manufacturing aluminium products and supplying them to manufacturers of aircraft for the Government, wherein it was provided that the prices which the latter was then charging to its customers should be reduced for the period 1st July, 1939, to 30th June, 1940, and that the amount by which the prices paid to the company were in excess of the reduced prices should be paid by the company to the Ministry. The agreement further provided that negotiations should be started not later than 30th June, 1940, for determining the rates to be charged for the periods following 30th June, 1940. The agreement was, in fact, concluded only on 12th October, 1942, whereby the prices to be charged by the company were fixed for the years, 1941, 1942 and 1943. In accordance with the agreement entered into on 12th October, 1942, a sum of pounds 2,743,469 was repai ..... X X X X Extracts X X X X X X X X Extracts X X X X
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