Die Jovis, 21° Junii 1956
Parliamentary
Archives,
HL/PO/JU/4/3/1039
Earl Jowitt
Lord
Oaksey
Lord Mac-
Dermott
Lord
Radcliffe
Lord
Tucker
HOUSE
OF LORDS
SOUTHERN
RAILWAY OF PERU LIMITED
v.
OWEN
(Inspector of Taxes)
21st
June 1956
Earl
Jowitt
MY LORDS,
I have had
the advantage of reading the Opinion which is about to be
delivered
by my noble and learned friend Lord Radcliffe, with which I
agree,
and have nothing to add.
Lord
Oaksey
MY LORDS,
I agree
that this appeal should be dismissed.
Mr.
Pennycuick, in his able argument for the Appellants, contended
that
the social legislation of Peru conferred upon the Appellants'
employees a
right to the compensation therein referred to in the
year of taxation, and
that as an employee could at any time give
the requisite period of notice
and claim the compensation at the
expiration of that period the amount of
compensation which would
then be due was a sum which the Appellants
were entitled to charge
against the profits of the year although, in fact, the
employee
had given no such notice during the year. In my opinion, the
fallacy
of this argument lies in the fact that the employees whose
com-
pensation the Appellants sought to charge against their
profits had not, as a
matter of fact, given their notices or
terminated their contracts, and it is
clear, and not disputed,
that no compensation was payable to them until their
service was
duly terminated.
The
Peruvian legislation contains certain provisions which entitle
the
Appellants to dismiss their employees for misconduct, and it
is clear that
until the contract of service is duly completed no
liability to pay the
compensation arises.
Reliance
was placed, during the argument, upon the Sun Insurance
Office
v. Clark, 6 TC 59, 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 Appellants are
permitted to deduct com-
pensation which they have not paid and
which they 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 upon a
contingency. When a debt is not paid at the time it is
incurred
its payment is, of course, contingent upon the solvency of the
debtor
but the liability is not contingent. Similarly, the
liability in the Sun
Insurance case 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.
The
circumstances in the present case may put an end to the
liability
altogether, but in the case of insurance for a period
the circumstance of loss
does not put an end to the liability but
merely makes payment obligatory in
pursuance of the liability.
2
After all,
the only question in the present case is whether the
compensation
should be deducted when it is in fact paid or should
be deducted before it is
paid and in circumstances in which it may
never be paid. In my opinion,
the reasoning and the judgments in
the Court of Appeal are correct and
should be affirmed.
Lord
MacDermott
MY LORDS,
In this
appeal the Appellant claims that, in the computation of its
profits
for each of the years of assessment under review, an
allowance should be
made in respect of its liability to pay to the
employees then in its service
in Peru certain lump sums which,
under Peruvian legislation, those employees
will be entitled to
receive from the Appellant on the due completion of their
service.
The appeal is therefore concerned with payments to be made after—
and
it may be long after—each of the relevant accounting periods
has ended.
No question arises as to the deduction of wages and
salaries currently paid
for services rendered. What the Appellant
contends is, in effect, that the
total cost of those services each
year included, in addition to current wages
and salaries, a
provision to meet the amount by which the services rendered
that
year have enhanced the lump sums that will eventually be
payable
under the Peruvian legislation. In short, the Appellant
maintains that its
employees earn each year a deferred as well as
a present remuneration
and that the former, no less than the
latter, must be taken into account if the
true yearly profits are
to be ascertained for the purposes of taxation.
My Lords,
as a general proposition it is, I think, right to say that
in
computing his taxable profits for a particular year a trader
who is under
a definite obligation to pay his employees for
their services in that year an
immediate payment and also a
future payment in some subsequent year,
may properly deduct not
only the immediate payment but the present value
of the future
payment provided such present value can be satisfactorily
determined
or fairly estimated. Apart from special circumstances, such
a
procedure, if practicable, is justified because it brings the
true costs of trading
in the particular year into account for that
year and thus promotes the
ascertainment of the " annual
profits or gains arising or accruing from "
the trade. As I
read the judgments, the substance of this proposition was
accepted
in the Court of Appeal; and before your Lordships the Crown,
without
making any formal concession, was not concerned to argue
strenuously
against it. The Crown's contention—and the view taken in
the
courts below—was rather to the effect that the
proposition did not apply
to the Appellant's case because (1) the
Appellant was not under a definite
obligation in any relevant year
to pay its employees lump sums at the end
of their engagements
since, in each individual instance, the right to receive
a lump
sum depended upon the fulfilment of certain conditions that made
the
Appellant's prospective liability contingent until the service was
duly
terminated ; and (2) it was impossible, in the circumstances,
to regard any
part of the lump sums as earned in or payable in
respect of any particular
year of service.
The first
of these arguments necessitates a reference to the effect of
the
relevant Peruvian legislation. This was summarised in the
Court of Appeal
by Jenkins L.J. in two paragraphs which were
accepted by both parties
and which read as follows: —
"1. '
In the event of,' that is,' upon ' the determination of any service
"
contract between the Company and any employee, whether from the
"
employee's death, expiry of the term, or notice of determination
given
" on either side, the Company is liable to pay
compensation calculated
" as later appears to the employee or
his representatives.
3
''2. The
above general proposition is subject to exception:: (A) in
"
the case of fixed term contracts where the contract has been
determined
" by the employee before expiry of the term
otherwise than on account
" of infringement by the Company;
and (B) in the case (apparently) of
" all contracts of
service where there has been wrongful conduct of
" certain
kinds by the employee, e.g., dishonesty or insubordination."
The
position, therefore, was that the Appellant's liability to pay a lump
sum
could only be avoided by some breach of contract or grave
misconduct on
the part of the employee concerned. It may be
correct to call such a liability
contingent, but I must say the
contingency seems to me too remote to
justify a prudent trader or,
for that matter, a competent accountant, in
ignoring the liability
until the day for payment has arrived. Whether, if
this appeal
related to but one employee and one lump sum, the degree of
the
contingency would, nevertheless, be such as to preclude a
present
allowance in respect of the future liability is a question
which, in my opinion,
does not call for decision on the facts of
this case. I do not forget that
the Court of Appeal looked at this
contingency argument from the point
of view of the individual
employee and may, therefore, be taken as of a
different opinion.
With respect, however, I think that that was the wrong
approach
or, perhaps more accurately, that it should have been taken a
stage
further. The question, as I see it, on this branch of the case,
was
not whether, in a given year, the Appellant's liability to pay
this employee
or that was contingent: it was whether the
Appellant's liability to make some
payment in respect of the lump
sums accruing for the benefit of all its
employees in that year
was in any relevant sense contingent. If that is the
right view, I
think the Crown's contention on this point must fail. It is
clear
from the accounts that the Appellant's employees during the
material
years were numerous and the chances of all, or even a
substantial proportion
of them, acting so as to forfeit their lump
sum rights seem to me to be
much too distant and improbable to
merit significance. Here, the case bears
a close resemblance to
the state of affairs with which this House had to deal
in Sun
Insurance Office v. Clark, (1912) AC 443; 6 TC 59. There
the
tax-payer, a fire insurance company, was held entitled, in
determining its
taxable profits, to deduct from its premium income
for the year an allowance
for unexpired risks on policies
outstanding at the end of the year. Forty
per cent, of the premium
income was accepted as a fair and reasonable
estimate of such
risks and the deduction was allowed as a proper method
of
ascertaining the true gains for the year in which the premiums were
paid.
Liability on each outstanding policy was, of course, highly
contingent. But
that there would be a loss on the collective risk
was a matter of commercial
certainty. On the facts, the situation
in this appeal appears to me to be
essentially the same. However
one may describe the Appellant's liability
as respects the lump
sum which may become payable to a single employee,
its liability
to make some payment at a future date on foot of the body
of
presently accruing lump sum rights cannot well be regarded as
contingent
within the world of ordinary business affairs. Whether
this future liability
can be quantified for the purposes of
taxation is another matter; but in
the degree of its certainty it
is not, in my opinion, to be distinguished in
any material respect
from the future liability which was taken into account
in the Sun
Insurance Office case. It was said that that decision related
only
to insurance business and had no application to the facts of
this appeal.
I see no reason for confining the scope of the
decision in this way. Its
ratio is much wider than that,
and is in my view applicable to cases producing
the same sort of
problem, whether they relate to contracts of insurance or not.
The
Crown's second submission raises a very different and, as it seems
to
me, a more difficult issue. It turns on the true nature of the lump
sum
payment made to an employee at the end of his service. If the
correct view
were that such payment should be regarded merely as a
statutory bounty,
as something independent of the length or value
of the services rendered
except for arithmetical purposes, I
should, as at present advised, find it
difficult to resist the
Crown's claim that it could only be allowed for in
the year of
payment; on this hypothesis it would be a trading expense of
4
that year
and not, I think, of any other year. It is, however, dear that
such
is not the nature of the payment in question. The Crown conceded
that
it was deferred remuneration, and that is what the Special
Commissioners
and the Court of Appeal have held it to be. As
Jenkins, L.J. put it,
" The right to this compensation is
regarded as part of the remuneration for
" the services
rendered by the employee ". There can, I think, be no doubt
that
this accords with the tenor of the Peruvian legislation. Thus,
Law
No. 6871, having made provision for the calculation of the
lump sum in
Article 1 (as modified) " at the rate of one
month's salary per yearly service
" time " says in
Article 2—
"
Payment, such as is referred to in the foregoing article, from the
"
legal viewpoint, represents a remuneration which the employer pays
"
for the work of his employee, whether the latter's engagement is
for
" an indefinite period or for a fixed time ..."
And Law
No. 9463, speaking in the same strain, adds—
" The
reduction in remuneration accepted by an employee shall not
"
impair in any way the rights acquired for services rendered ... as
"
Compensation should be calculated per years of service in
accordance
" with the remuneration received until the time of
the reduction.
" Following compensation will be calculated in
accordance with the
" reduced remuneration."
The lump
sum payment has, therefore, to be regarded as deferred remunera-
tion
in respect of the entire period of service. This at once puts an
obstacle
in the way of debiting the whole sum in the accounts for
the last year of
service, as the Crown contends should be done,
since to do so would be
to inflate the cost of the services
rendered for that year beyond the actual
figure and thus produce a
corresponding error in the amount of the annual
profits. This
obstacle may not conclude the matter and the error it induces
may
have to be accepted if no better way of computing the true profits
is
open. But before that can be conceded a negative answer must be
found to
one or other of two questions. The first of these, which
is that raised by the
submission under consideration, comes to
this—can the amount of a lump
sum payment properly be
regarded as made up of parcels each of which
is attributable to a
particular year of service? And the second question
is whether, if
the lump sum can be allocated in that manner, a fair estimate
can
be made for each year of the provision required to meet the
prospective
liability.
My Lords,
the first of these questions would present little difficulty if
each
lump sum was simply the amount found by adding together a
twelfth part
of the remuneration actually paid in each year of
service. In that event
the method of computation, coupled with the
circumstance that the lump
sum is to be regarded as deferred
remuneration, would seem to relate the
payment to each year of
service almost automatically. But that is not the
scheme of the
Peruvian legislation, the effect of which, in this connection,
is
thus summarised by Jenkins L.J.: —
" The
compensation is an amount equivalent to one month's salary or
"
one-twelfth of a year's salary at the rate in force at the date of
deter-
" mination for every year of service, provided that
the right to compensa-
" tion accrued up to any point of time
is not liable to be diminished
" in amount by subsequent
reduction in pay."
This
provision undoubtedly leads to anomalies if one is to regard
each
year's accretion to a lump sum as remuneration earned in that
year, the
possible effect of an increase of remuneration (to take
what is perhaps the
most glaring example) being to raise the
increment for the year of increase
above that of subsequent as
well as previous years. It is, f think, true to say
that this
consideration led Upjohn J. and, in the Court of Appeal, Jenkins L.
J.
to hold against the Appellant on this aspect of the matter.
But, while I find
the point far from easy, I am of opinion that
the anomalies referred to have
been given more than their due
weight and that the true view is that the
yearly Increments by
which a lump sum is built up ought to be reckoned
5
for
present purposes as remuneration in respect of the years in which
they
accrue. It must be remembered that the anomalies are the
result of a
statutory scheme and that the criterion of what is
sensible or reasonable
contractually does not arise. Moreover, if,
as I think, the lump sum is to
be regarded as deferred
remuneration in respect of the entire service the
case for
relating each incremental step to the remuneration for the year
in
which it occurs cannot be lightly disregarded. After all, and
whatever may be
said of the manner in which the increments may
fluctuate in amount, the
scheme is such that at the end of each
year an employee can tell with
certainty not only what his lump
sum will be if he then retires and does
not forfeit his rights,
but also how much each year of previous service has
added to his
entitlement. And finally, the language of Law No. 9463 with
its
reference to "rights acquired for services rendered"
in a context relating
to a point during the service and not at its
end, goes at any rate some way
to show that the legislation
regarded the lump sum as accruing throughout
the service.
For these
reasons I consider that the Crown has failed in both the
sub-
missions discussed and, accordingly, I would hold that the
Appellant was
right in contending that in principle it was
entitled to make a deduction
each year in respect of its
prospective lump sum liabilities, provided such
deduction can be
fairly estimated or otherwise satisfactorily assessed.
There
remains the question which this proviso raises and which I
have
already posed. The difficulty here is that the deduction
sought by the
Appellant throughout has been the aggregate of the
yearly increments
by which the value of the future lump sum
payments has been increased.
That, I think, must be wrong as,
apart from any adjustment to be made
on account of possible
forfeitures, this deduction makes no attempt to
reflect the
present value of payments which may not have to be made
for
anything up to the span of a man's industrial life. If the position
is that
no fair estimate or satisfactory computation of the
provision to be made as
respects the Appellant's prospective
liabilities can be arrived at, then that
is an end of the matter
and the appeal must be dismissed. I am not disposed,
however, to
assume that that is the position or that it is beyond the power
of
those skilled in such matters to produce a series of acceptable
deductions
for the years affected by these proceedings. I express
no opinion as to
whether or not this can be done. I do not know.
But on the whole I feel
the Appellant should have an opportunity
of putting this question to the
test. If one may judge from the
terms of the Case Stated it was not debated
before the Special
Commissioners and it must, I think, have been obscured
in the
courts below by the other issues which were the subject of a
vigorous
controversy throughout and were decided, wrongly as I
consider, against the
Appellant. While I appreciate that your
Lordships would be reluctant to
take any step likely to start this
litigation on a further round of the courts,
the outstanding point
is now so much a matter of fact that there is, I think,
but little
danger of this. For my part, therefore, I would favour a remit to
the
Special Commissioners to ascertain whether it is practicable
to arrive at
satisfactory deductions and, if so, to determine what
they should be.
Lord
Radcliffe
MY LORDS,
The
Appellant has been operating its railway in Peru under the
obligations
of a statutory scheme by virtue of which its
employees, generally speaking,
are entitled to receive from it a
lump sum payment on retirement, death or
other termination of
service. In effect, entitlement does not depend on any
prescribed
length of service: on the other hand an employee can forfeit
his
right to payment by wrongful conduct such as dishonesty or
insubordination
or by failure to give due notice of retirement,
which in many cases is only
a short one. Employees on fixed term
contracts must complete their term
without breach, except in the
case where the company itself is in default.
32221 A 3
6
In my
opinion the solution of this case does not depend on any
precise
analysis of the Appellant's obligations under Peruvian
law. In this I am
at one with the Special Commissioners, who nave
set out in the Case all
that it is necessary to know on this
point. It amounts, I think, to this.
The payments that fall due
are retirement benefits and no payment is exigible
from the
company until service has been terminated. The amount of benefit
is
arrived at by taking a prescribed proportion of the salary of the
closing
year and multiplying it by the number of years of service,
but this calculation
is subject to a not unimportant proviso to
the effect that if an employee's
rate of salary or wage is reduced
during the course of his service the
reduction " shall not
impair in any way the rights acquired for services
" rendered
.... as Compensation should be calculated per years of service in
"
accordance with the remuneration received until the time of the
reduction.
" Following compensation will be calculated in
accordance with the reduced
" remuneration " (Law No.
9463). Thus, what is paid in the year of retire-
ment is paid in
respect of the whole period of service and is indeed declared
to
represent a " remuneration which the employer pays for the work
of
" his employee " (Law No. 6871). On the other hand,
it is a single sum and
I do not think that it can be said that any
particular part of what is paid is
in law the earning of any
particular year. It might be plausible to say so
in the case of a
salary that never varied: but such a description cannot really
be
made to fit the case of the salary that increases from time to time
during
the period of service.
Now the
question is, how ought the effects of this statutory scheme to
be
reflected in the Appellant's accounts of the annual profits
arising from its
trade? One way, which is certainly the simplest
one, is to let the payments
made fall entirely as expenses of the
year of payment and ignore any question
of making provision for
the maturing obligation during the years of service
that precede
it. This is what the company seems to have done up to the
year
ending 30th June, 1947. and it is the system which is, according to
the
Crown, the only one which the law of income tax permits. It
has one con-
siderable advantage: no element of estimate or
valuation appears in the profit
assessment and nothing is charged
to profits except the actual cash outgoing.
But, when this has
been conceded, I think that there is the very serious
disadvantage
to be set against the cash basis that it affords a
comparatively
inefficient method of arriving at the true profits
of any one year. The
retirement benefit is not, obviously, paid to
obtain the services given in the
year of retirement. The incidence
of retirement payments must be variable
from year to year, and
they may inordinately depress the profits of one
year just as they
may inordinately inflate the profits of another. It is true
that
the company carries on business from one year to another, but it is
not
charged on the average of its annual profits. Tax rates and
allowances
themselves vary and, apart from that, to charge tax on
a profit unduly
accelerated or unduly deferred is, in my opinion,
no more respectable an
achievement than to admit that the annual
accounts of business do in some
cases require the introduction of
estimates or valuations if a true statement
of profit is to be
secured.
Another
method is that which the Appellant is seeking to establish
with
regard to its assessments for the four years 1947-50. I will
say at once that
what it aims at (I do not say, what it achieves)
appears to me to be a more
accurate assessment of true annual
profit than that which could be provided
by the other method. When
I am told, then, that its adoption is banned
by some established
principle of law, to which your Lordships are bound to
give
effect, I feel that I must enquire closely what that principle of law
is
and upon what understanding of accountancy practice the
principle is said
to be based. For the overriding principle of law
is still, I believe, as it
was stated by Lord Haldane in Sun
Insurance Office v. Clark 6 TC 59
at p. 78: " It is
plain that the question of what is or is not profit or gain
"
must primarily be one of fact and of fact to be ascertained by the
tests
" applied in ordinary business. Questions of law can
only arise when
" (as was not the case here) some express
statutory direction applies and
"excludes ordinary commercial
practice, or where, by reason of its being
" impracticable to
ascertain the facts sufficiently, some presumption has to be
7
"invoked
to fill the gap." And our task is: not made any easier by
the
knowledge that, though the law with its system of precedents
may sometimes
seem to stand still (I hope that it does not), it is
quite certain that the
techniques and practices of commercial
accountancy are very far from
static.
What the
Appellant claims the right to do is to charge against each
year's
receipts the cost of making provision for the retirement
payments that will
ultimately be thrown upon it by virtue of the
fact that it has had the benefit
of its employees' services during
that year. As a corollary it will not make
any charge to cover the
actual payments made in the year in respect of
retirement
benefits. Only by such a method, it is said, can it bring against
the
receipts of the year the true cost of the services that it has used
to earn
those receipts. Generally speaking, this must, I think, be
true. For, whereas
it is possible that any one of its many
employees may forfeit his benefit and
so never require a payment,
the substantial facts of the situation are that
when the company
has paid every salary and wage that is due for current
remuneration
of the year it has not by any means wholly discharged itself
of
the pecuniary burden which falls upon it in respect of the year's
employ-
ment. This is a long-term application of the practice by
which provision
for holidays with pay in the coming year is
charged in part against the
receipts of the previous year. It does
not seem to me inconsistent with
the theory on which the claim is
based that in the year when an increase of
salary takes place and
the expectation of a larger ultimate payment
materialises an
adjustment has to be made to take care of what has thus
become the
under-provision of earlier years. I agree that it is arbitrary
to
describe such an adjustment as accruing in respect of that
year's service: but
on the other hand it is a provision which is
required in that year to take
account of the increased burden
which the year's salary for the year's service
has thrown upon the
employer.
Of course,
the company's claim must be understood in the light of the fact
that
it is an employer dealing with the cost of services rendered to it,
by which
it itself has received monies, say fares and freights,
which enter into the
current year's receipts. Generally speaking,
I suppose, its takings are cash or
short-term credits. The
considerations which apply to this situation are not
necessarily
valid in other fields of income or expenditure. But in this field
I
agree that provision for retirement payments is more likely to
give an accurate
reflection of the true cost of earning the year's
receipts than merely charging
against them the year's payments to
employees who retire in the year.
The Courts
have not found it impossible hitherto to make
considerable
adjustments in the actual fall of receipts or
payments in order to arrive at a
truer statement of the profits of
successive years. After all, that is why income
and expenditure
accounting is preferred to cash accounting for this purpose.
As I
understand the matter, the principle that justified the attribution
of some-
thing that was in fact received in one year to the
profits of an earlier year, as in
such cases as Isaac Ho/den &
Sons, Ltd, Ltd. v. Commissioners of Inland Revenue
12 T.C. 768
and Commissioners of Inland Revenue v. Newcastle
Breweries
Ltd. 12 TC 927, was just this, that the payment
had been earned by services
given in the earlier year and
therefore a true statement of profit required that
the year which
had borne the burden of the cost should have appropriated to it
the
benefit of the receipt. The principle is clearly stated in the speech
of Lord
Simon in Commissioners of Inland Revenue v. Gardner
Mountain &
D'Ambrumenil Limited 29 TC 69, and I take
leave to quote his words
(see p. 93): " In calculating the
taxable profit of a business on Income Tax
" principles . . .
services completely rendered or goods supplied, which are
"
not to be paid for till a subsequent year, cannot, generally
speaking, be
" dealt with by treating the taxpayer's outlay
as pure loss in the year in which
" it was incurred and
bringing in the remuneration as pure profit in the
"
subsequent year in which it is paid, or is due to be paid. In making
an
" assessment to Income Tax under Schedule D the net result
of the trans-
" action, setting expenses on the one side and
a figure for remuneration on
" the other side, ought to
appear (as it would appear in a proper system of
"
accountancy) in the same year's profit and loss account, and that
year will
8
" be
the year when the service was rendered or the goods delivered. . .
.
" This may involve, in some instances, an estimate of what
the future
" remuneration will amount to (and, in theory,
though not usually In practice,
" a discounting of the amount
to be paid in the future). ... If the accounts
" ... were
made up before the amount of the commission was ascertained, a
"
provisional estimate of what the amount would be might be inserted in
the
" first place and could be corrected when the precise
figure was known, by
" additional assessment or by a return
of any excess within six years of the
" original assessment."
Lord
Simon's principle is not stated in terms which fully cover the
present
case. For he speaks of " services completely rendered
". Moreover, the
decisions I have mentioned were all cases of
receipts the precise amount of
which had been ascertained, though
after the end of the year to which they
properly belonged. No
doubt it is much easier to get a satisfactory method
for dealing
with such cases. In the present case the analogue would be to
wait
until each retiring payment was made and then to write it back
in
appropriate proportions over the years covering the whole
period of service.
But such a method, even if ideal, is not
practical politics and we can. I
think, put it out of our minds.
There seems, therefore, to be no alternative
between letting each
payment fall upon the year in which it is made
or adopting some
scheme of current provision such as the Appellant
contends for. It
is clear, at any rate, from what I have quoted above
that there is
nothing improper in admitting valuations or estimates if
by so
doing a truer balance is arrived at between the receipts of a
year
and the cost of earning them or the expenses of a year and
the fruits
of incurring them. Such estimates were in fact directed
by the Court of
Appeal and by this House in John Cronk &
Sons, Ltd. v. Harrison 20 TC 612
and again by this House in
Absalom v. Talbot 26 TC 166. See too the
judgment of Lord
Greene, M.R. in Johnson v. W.S. & Try, Limited 27 T.C.
167
at p. 182. The decision in the last-mentioned case is, I
think, of value in
illustrating the point that, however desirable
it may be to bring in a valuation
or estimate in order to give a
better balance to a year's accounts, it cannot
be right to do so
if the figure which is to be inserted, " hedged round . . .
"
with every kind of contingency and speculation ", is too
uncertain to be
fairly treated as a receipt. What is true of
receipts is true of liabilities. In
my opinion, it is that point
which constitutes the real difficulty of the present
case.
But
there is no difficulty if we accept the main argument of the
Crown.
That argument is that, quite simply, there is a rule of law
which forbids the
introduction of any provision for future
payments in or payments out, if
the right to receive them
or the liability to make them is in legal terms
contingent
at the closing of the relevant year. The rule, it seems, is
absolute
and must be adhered to whatever the current
principles or practices of
commercial accountancy may require
as a method of ascertaining the year's
profits. And this is the
argument which hitherto has prevailed in the High
Court and the
Court of Appeal. Now, in my opinion, there is no such rule
of
law governing the ascertainment of annual profits. Where does it
come
from? Not from anything to be found in the Income Tax
Acts, which.
indeed, by the well-known rule limiting the
exclusion of debts, show a
different and, as I think, a
more realistic approach to the problem.
Not from any decided
authority which is binding on your Lordships. On
the contrary,
there are two decisions of this House which negative
the
existence of any such rule of law. In Sun Insurance
Company v. Clark,
supra, the House had to deal with the
ascertainment of the profits of a fire
insurance business which
had two special features: it was growing, and the
practice was in
some cases to take premiums covering a longer risk than one
year.
The gross receipts inevitably included payments received in respect
of
unexpired policies, of each of which it could truly be said
that any liability
under it was contingent on the future maturing
of the risk. No fire, nothing
to pay. Yet the decision of the
House recognised that it was correct for the
insurance company to
ascertain its profits for each year by carrying forward a
fixed
percentage of the gross premium income of the year as a provision
9
against
unexpired risk. No doubt the carry-forward was treated as a
receipt
of the succeeding year and that year charged again with a
new provision in
respect of its new premiums. But the point is
that the profit of each year was
held to be correctly ascertained
despite the inclusion of a provision for con-
tingent liabilities.
No doubt too this was insurance business. But insurance
business
does not live in a world of its own in income tax law. What it
does
is to throw up in an accentuated form some of the problems
that affect,
though perhaps in less degree, the ascertainment of
the true profit of many
other businesses. And in some cases
special rules have to be evolved to
deal with them.
The other
decision is Cronk v. Harrison, supra. The trader in that
case
had acquired by his trading a contingent right to receive
certain monies
deposited with a building society. It would be
impossible to say of any one
of these deposits in the year in
which it was made that it represented a
certain right for the
trader to be paid any part of it in the future, for by
the terms
of the arrangement with the house purchaser default on his part
might
involve forfeiture or reduction of the trader's deposit. It was
not
money in the trader's hand, and, moreover, it might never be.
Yet this House
upheld the order of the Court of Appeal that the
contingent rights ought
to be brought in as receipts of the year
in which they arose, though at a
valuation (if feasible), not at
their face value.
I am
satisfied by these decisions that there is no such rule of law as
is
suggested. The answer to the question what can or cannot be
admitted
into the annual account is not provided by any exact
analysis of the legal
form of the relevant obligation. In this
case, as in the Sun Insurance case,
you get into a world of
unreality if you try to solve your problem in that
way, because,
where you are dealing with a number of similar obligations
that
arise from trading, although it may be true to say of each
separate
one that it may never mature, it is the sum of the
obligations that matters
to the trader, and experience may show
that, while each remains uncertain,
the aggregate can be fixed
with some precision. For the trader the practical
question is
always the same in these cases—How much more shall I have
to
pay out or shall I be able to get in than my current accounts of
the
year are recording? Legal analysis of the obligation may
present it in a
variety of different forms. There is the deferred
payment which is subject
to nothing more than the practical
contingency that it may not be received.
That is dealt with, as we
know, by bringing it in at its face value, subject to
allowance,
or, in some cases, at a valuation. There is the future payment
for
work done which is only legally exigible if the whole work is
completed.
A large part of this particular aspect must be covered
by such items of receipt
as work in progress, but I do not know
enough of the methods of valuing
or allowing for this to speak
with any confidence about it. And, lastly,
there is the contingent
obligation to make a future payment, which is our
present case.
But, whatever the legal analysis, I think that for liabilities
as
for debts their proper treatment in annual statements of profit
depends
not upon the legal form but upon the trader's answers to
two separate
questions. The first is—Have I adequately
stated my profits for the year
if I do not include some figure in
respect of these obligations? The second
is—Do the
circumstances of the case, which include the techniques of
estab-
lished accounting practice, make it possible to supply a
figure reliable enough
for the purpose? The authorities H. Ford
& Co., Ltd. v. Commissioners of
Inland Revenue 12 T.C.
997, Peter Merchant Ltd. v. Stedeford 30 T.C. 496.
James
Spencer & Co. v. Commissioners of Inland Revenue 32
T.C. 111,
are no doubt very relevant in answering the second
question, as must be the
mere fact that an obligation is in its
own terms contingent; but I regard
them rather as illustrations of
the kind of answer that should be given than
as laying down any
general principle or rule of law.
Nor can I
see what useful instruction is to be obtained from Lord
Clyde's
judgment in Whimster & Co. v. C.I.R. 12 T.C.
813. First, the learned
judge's formulation of some general rules
according to which annual profits
should be determined for
purposes of Income Tax is explicitly based on his
understanding of
what he calls "the correct principles of commercial
10
"
accountancy ". Secondly, his observation, no doubt correct, that
annual
profits properly determined are not to be treated as
reduced by the circum-
stance that some part of them may be
prudently reserved from distribution
by the owner of the business
to take care of an apprehended loss from future
trading offers no
solution to the problem of the present case, in which the
accountants
who have given evidence would say, I suppose, that they were
not
advocating the making of a reserve, but seeking to evaluate a
current
cost of working.
This
brings me at last to the facts of the present case. I am bound to
say
that, but for what has been found by the Special Commissioners,
I
should have thought that the charges for retirement benefits
which the
Appellant has claimed to make in the four relevant years
were well on the
wrong side of what was permissible. When account
is taken of all the
circumstances I should have thought that the
sums charged were a very long
way from affording a scientific
appraisement of the additional burden arising
in respect of the
year's services; and were, therefore, in the nature of a
rough
reserve against the future rather than a measured provision.
Because
what the Appellant has done is simply this. It has
calculated what sum
would be required to be paid to each employee
in respect of retirement
benefit if he retired, without
forfeiture, at the close of the year: and the
aggregate of what is
required is set aside in so far as the year has con-
tributed to
the aggregate. I think that that is a sufficiently accurate
descrip-
tion of the process as it was explained to us. But it
seems to me to leave out
of account several factors that are
essential to the appraisement.
First,
there is the contingency itself that any one benefit may in the
end
be forfeited. This seems to me the least important of the
factors, since it
is extremely probable that most will be paid;
and on the fact found that
the Appellant had never yet failed to
pay retirement benefit to an employee
on any ground, I think that
the weight of the contingency is in effect
nothing. But, secondly,
it must not be forgotten that these benefits and their
scale are
imposed by legislation, not by voluntary contract: and one
cannot
exclude the possibility that both the form and the scale of
what has to be
paid may be altered again without the company's
consent. Thirdly, there
is the very important factor of discount.
To reserve each year's increment
at face value, as the Appellant
does, presents itself to me as making a serious
over-provision. It
is true that trade debts on short-term credit are not brought in
at
a discount; but here we are dealing with liabilities which cover a
whole
period of service and of which some may be deferred 30 or 40
years before
payment. No doubt each is at call at the close of the
year, in the sense that
any employee may retire and claim his
accrued benefits on notice. But the
point is that most of the
staff would not be doing that: and to provide each
year's
increment at face value on the ground that it is in that sense
presently
payable seems to me to be falling into the same error of
confusing the
individual legal form with the substance of the
whole, which I find amiss with
the argument for the Crown.
In my
opinion, therefore, the Appellant must be wrong in omitting to
allow
for discounting. So much, indeed, was conceded by its
counsel in the course
of argument. But then, it was said, that
would be quite easy to do. I can
see that it would be easy if the
age of each workman and employee were
known, the retirement age
were fixed and each of them were to remain in
service until that
age. But then some will die and some will leave service
before
retiring age and these factors accelerate payment and so pro
tanto
increase the present value of each prospective payment.
Well, it is said, given
sufficient information, it will be
possible to evaluate these factors by averages
based on past
experience and make adjustments of the discount accordingly.
Perhaps
it would, but the Case Stated gives us no information at all on
the
matter. And the averages themselves may be falsified by
events, so leading
either to over-provision or under-provision for
the risks. If one is really
going to formulate a water-tight
scheme of providing for such a difficult
problem, I should expect
to find that it included an arrangement for periodical
revision of
the aggregate of the outstanding appropriations in the light of
the
current risks, so that anything over-provided could be brought
back into
taxation.
11
Bearing
these consideration: in mind I find it impossible to give any
con-
clusive weight to the finding of the Special Commissioners
that the Appellant':
method of face value appropriations ought to
be upheld, because " it was a
" matter of correct
accountancy practice in England to make provision in
" the
accounts for the sums m question in the circumstances of this case."
I
wish that I could, because I should view with dismay the
assertion of legal
theories as to the ascertainment of true annual
profits which were in conflict
with current accountancy practice
and were not required by some special
statutory provision of the
Income Tax Acts. And it is apparent that in this
case the Special
Commissioners' finding was arrived at after hearing the
evidence
of the company's auditor and another independent accountant
of
distinction. The auditor said, as auditors have said before in
other cases,
that he " would not have signed the balance
sheet without a qualification,
" unless the afore-mentioned
provision had been made."
All this
is very important, because, of course, accountants are very
specially
concerned with the problems that attend the true
ascertainment of a year's
profit and the establishment of
techniques that assist in this. But, for all
that, there is
nothing in the Case that seems to me to fix on the point that
is
really the heart of this appeal. The requirements that an auditor
may
make before signing a balance sheet (I assume that the words
used in the Case
are meant to cover the statutory reference to the
profit and loss account) do,
no doubt, cover his opinion that that
account gives a " true and fair view "
of the profit for
the financial year: but I do not think that such requirements
are
necessarily the same thing as the auditor's opinion that some
particular
provision could not be omitted without compromising the
true and fair view.
It is not possible completely to equate the
balance shown by a company's profit
and loss account with the
balance of profit arising from the trade for the year.
The word "
provision " is becoming a technical one in contradistinction to
the
word " reserve " owing to the definitions of the two
terms supplied by the
Companies Act 1948, Schedule VIII, Part IV,
paragraph 27: but the word
" provision " includes any
amount written off or retained " for any known
"liability
of which the amount cannot be determined with substantial
"
accuracy ", and J think that one is bound to say that references
to an
auditor's duty under the Companies Act take us into a field
that is not
exactly the same as that in which the annual
profits of trade should be
ascertained for the purposes of
income tax. There is nothing in the evidence
or the Special
Commissioners' finding which supplies an answer to what I
regard
as the vital question relevant to these cases—is the sum
provided an
essential charge against the receipts of the trade in
order to enable a true
profit from that source to be stated for
the year in question? And, as I see
it, such a question cannot
be answered just by one man's opinion. It is
important to know
how far it is supported by accepted theory or established
practice.
In the absence of any light on all these points, I think that
your
Lordships are bound to use your own judgment, supported,
indeed, as it is,
by the admissions made by the Appellant's
counsel during the course of the
hearing and by the fact that an
alternative, albiet a rough and ready, method
is available which
has, after all, been adopted in the past.
My Lords,
I feel bound to come to the conclusion that the appeal fails.
I do
not think that this is an occasion upon which the case should be
remitted
to the Special Commissioners to see whether a new and
more satisfactory
method of provision could be extracted from
evidence. The Appellant
has stood throughout on its claim that the
provisions that were claimed before
the Special Commissioners were
those that it was entitled to make, though
I gather that during
the course of the various appeals it was admitted that
it might be
proper to discount. To send the case back, when it is not
even
certain that a proper method can be found, is really to start
it all over
again and would apparently involve the hearing of
further evidence. That
is to go beyond the function of a final
appeal.
Lord
Tucker
MY LORDS,
I
have had the advantage of reading in print the Opinion of my noble
and
learned friend. Lord Radcliffe. which has just been delivered.
I agree with
12
him that
there is no such absolute rule of law governing the ascertainment
of
annual profits as was contended for by the Crown in the present case,
and
that there is no ground for holding that the decision of this
House in Sun
Insurance Office v. Clark 6 TC 59 must be
confined exclusively to insurance
companies. I also agree, for the
reasons which he has given, that the
finding of the Special
Commissioners that the appellant's method of account-
ing is in
accordance with "correct accountancy practice" cannot, in
the
circumstances of this case, be regarded as conclusive.
I would
accordingly dismiss the appeal.
(32221)
Wt8124—124 35Vol. 7/56 D.L/PA/19
