TaxTMI 
TaxTMI 
1964 (6) TMI 56
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....m 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. 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 GBP 100 divided into 100 shares of GBP 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 (trans....
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....Securities (Gross) 1,686,198 12 2 1,689,241 14 9 The figure of GBP 1,317,565 for purchases of unquoted investments represented the cost to the respondent of the purchases of the entire share capital of three companies, i.e.: on December 10, 1954, B&Co., Wool Merchants (Bradford) Ltd. GBP 175,075; on March 3, 1955, Cranwell (Holdings) Ltd. GBP 732,823; and on March 25, 1955, N.E.T. Holdings Ltd. GBP 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 res....
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....ld be allowed and the direction discharged. It was contended on behalf of the Crown that the respondent was an investment company within the meaning of section 257(2) of the Income Tax Act, 1952, to which the provisions of section 245 of the Income Tax Act, 1952, applied, and that, therefore, the direction dated January 22, 1960, of the special commissioners was correct in law; and that the appeal should be dismissed and the direction confirmed. The commissioners gave their decision in writing on March 20, 1961, in the following terms (so far as is material to the present case): "The first question for our decision is therefore whether or not the company is an investment company. The company was incorporated in August, 1954, to carry on the business of a finance company, buying and selling stocks and shares, and this it did; and in our opinion, having regard to the decision in the case of J.P. Harrison (Watford) Ltd. v. E.J. Griffiths*, there can be little doubt that it was a trading company. The real question is whether it also falls within the definition of an investment company within the meaning of section 257(2) of the Income Tax Act, 1952. In the period covered by the a....
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....nt company within the meaning of section 257(2) of the Income Tax Act, 1952...In the final result the direction of the special commissioners is confirmed." The respondent appealed. Ungoed-Thomas J., allowing the appeal, held that as the primary object in this particular case was to obtain dividends in one swoop by dividend stripping, the operation was merely a means of turning shares into cash and profits as part of the respondent's trade in dealing in shares. The dividends, therefore, were not investment income but trading receipts, which should be included for computation in trading profits and charged as income under Schedule D within section 525 of the Act. In those circumstances the respondent was not an investment company and the direction of the commissioners should be discharged. On appeal, the Court of Appeal affirmed that decision. JUDGMENT Appeal from the Court of 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 (Ungo....
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....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 profit 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 s. d. Quoted 166,208 5 0 Unquoted 1,317,565 1 7 s. d. 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 s. d. Quoted 28,814 10 6 Unquoted 424,1....
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.... 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 (Bradford) Ltd. ? 146,769; Cranwell (Holdings) Ltd. ? 252,345; N.E.T. Holdings Ltd. ? 25,000, making a total of ? 424,114. 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 o....
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....d 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 company, such dividends were nevertheless trading receipts of the company's trade inasmuch as they satisfied the definition of earned income 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 arisi....
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....t under Schedule D. This is not controverted. (ii) Dividends which have suffered deduction of tax under section 184 of the Act of 1952 do not fall to be brought into the computation of the profits and gains of a trader for the purposes of Case I of Schedule D. As to (ii), (a) this is the effect of the statutory provisions; (b) even if the issue does not rest on statute but on some equitable principle, the only practicable way to prevent double taxation is to leave such dividends out of the aforesaid computation; and even if there are alternative means of preventing double taxation, it is submitted that the House should be slow to disturb a practice which has subsisted for a very long time and the existence of which has been accepted by subsequent legislation. [Reference was made to sections 122, 123, 127(1), 184, 185, 186, 341(1)(3) and 342(1)(4) of the Income Tax Act, 1952.] Viscount Simonds' dictum in Cenlon Finance Co. Ltd. v. Ellwood* that it had always been the practice to include taxed dividends in the computation of profits taxable under Case I was made per incuriam. Affidavit evidence given in Rex v. Commissioners of Income Tax for the City of London** shows that it ....
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....hieved within the framework of the Income Tax Acts. If any other course is adopted difficulties and anomalies would arise, some of them to the disadvantage of the taxpayer. It is not clear from the references made to an equitable adjustment whether it is to be an adjustment whereby a trader who has sustained no loss is to be entitled to reclaim the tax lawfully deducted from a dividend or an adjustment whereby a trader is not to be taxed again under Case I up to the amount of the dividend, but there is no authority for these procedures in the Income Tax Acts and to adopt either of them would be in conflict with the provisions of those Acts. Generally, the principle of Fry v. Salisbury House Estate Ltd.(4) is applicable here: see per Lord Atkin. As to the comparable position in respect of interest on Government bonds which have suffered deduction of tax under Schedule C, see Thompson v. Trust and Loan Co. of Canada(5), per Lord Hanworth M.R. [Reference was also made to Griffiths v. J.P. Harrison (Watford) Ltd.(6); Argosam Finance Co. Ltd. v. Oxby.(7)] F. Heyworth Talbot Q.C. and H. Major Allen for the respondent company. The question is: do these taxed dividends come into the ....
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....ying on of its trade, and therefore do not constitute "investment income." In fine, these dividends are trading receipts and not income per se, and there are no grounds for excluding them from the charging words of Case I of Schedule D. [Reference was also made to section 54 of the Income Tax Act, 1842; sections 1, 2 and 185 of the Income Tax Act, 1952, and to Fry v. Salisbury House Estate Ltd.**] Alan Orr Q.C. replied. Their Lordships took time for consideration. June 4, 1964. LORD REID. My Lords, the respondent company was incorporated in August, 1954, with a capital of 100 ? 1 shares. At the relevant period 83 of these shares were held by two persons as trustees. The main object of the company was to carry on the business of stock and share dealers. Its most important venture was to purchase in December, 1954, and March, 1955, the entire share capital of three companies for sums amounting in all to ? 1,317,565. It financed these purchases by borrowing from its bankers 93 per cent. of the value of these shares. These three companies held large amounts of accumulated profits which had borne tax, and soon after purchasing them the respondent caused them to declare di....
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....ich was in fact followed was correct, and that the dividends were properly left out of that account. If that is right, then it is not now disputed that these dividends were investment income, that the respondent was an investment company, and that the special commissioners' direction was properly given. But the respondent now says that these dividends ought not to have been excluded from the profit and loss account and that therefore a properly framed account would have shown no loss. Counsel for the respondent agrees that if his contention is right the respondent ought not to have been repaid anything under section 341 but the respondent has not offered to repay the sum of ? 404,020. So the question now in issue is the question how a dealer in stocks and shares ought to treat dividends accruing to him from shares which he has bought in the course of his trade. It was decided in Cenlon Finance Co. Ltd. v. Ellwood* that a capital dividend which is not paid under deduction of income tax must enter his profit and loss account and the respondent maintains that the same rule must apply to dividends paid under deduction of tax. The question how dividends paid under deduction of....
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....unt those trading receipts which consisted of dividends received by him after deduction of tax. The respondent now says that the practice has always been wrong. In my opinion, it was right. Neither view can be derived directly from any provisions of the Income Tax Act. If the words of the Act were applied literally the result would be double taxation of the same income, but it has been said again and again that the Act cannot be so read as to authorise that. If the respondent's view is right, it is necessary to bring in some form of equitable adjustment after the assessable profit has been determined. Let me suppose that a trader in stocks and shares has received ? 5,000 net in dividends which have borne tax. The respondent's counsel concedes that in order to make his scheme work it is necessary to bring in not the net sum which the trader actually received but the gross amount of the dividends. If the standard rate were 10s. in the pound, the gross amount would be ? 10,000 and it is that sum which the respondent says must be brought into the account. Then suppose that apart from such dividends the trader has made a profit of ? 4,000. On the respondent's view, the pr....
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....ement not authorised by the Act. I can find nothing to recommend the respondent's method. It seems to be true that if it had been adopted earlier it would have prevented the abuse of dividend stripping. But the fact that it never seems to have occurred to the highly skilled advisers of the Crown to try to combat the abuse in that way is sufficient in itself to make me look on the method with great suspicion. Instead of trying to adopt it, Parliament had to be asked to pass complicated legislation on the assumption that the method then in use was correct. If these dividends do not even enter into the computation of the respondent's profits for the purposes of Schedule D, they are plainly not charged under Schedule D and are, therefore, not earned income within the meaning of section 525. But then it cannot be denied that they were income of the respondent, and they were by far the largest part of its income. If they were not earned income then they must come within the definition of investment income in section 257. It follows that the respondent was an investment company within the meaning of that section and that the only ground of appeal against the decision of the ....
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....mpany. Actually, its main operations during the period consisted in buying, on a loan conveniently supplied by its bankers, unquoted investments representing the entire share capital of three limited companies which, no less conveniently, were "full of dividend." The respondent, which had a share capital of ? 100, was thus enabled to spend ? 1,317,565 in buying these blocks of shares, and, having bought them, to pay itself in cash dividends to the total amount of ? 927,408 out of the resources of the three companies. This sum, if grossed up at the standard rate of dividend current for the year, represented ? 1,686,198. The operation left the shares much reduced in value, and, as they were still held by the respondent at March 31, 1955, they were entered in its trading account as an item of stock in hand at a market value of ? 424,114 pound in all. The respondent treated itself as having suffered a trading loss for the period to the amount of ? 895,487, almost entirely made up of the loss on these three items, and put in a claim to the Inland Revenue under section 341 of the Act on the basis that, having suffered this loss in its trading income account, it was entitled to relief pro....
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....to a figure of some ? 800,000 instead of the supposed loss of ? 895,487. Unless there is something in the argument (there is nothing in the Act) to obliterate the fact that the respondent had suffered tax on these dividends, it would still be true to say of it that in the half-year its income consisted mainly of investment income. However, I do not pursue this and the kind of absurdity to which it gives rise, because I think that the argument itself is ill-founded and is the prime author of what would be an absurd result. Since, however, the argument has found favour with the Court of Appeal owing, I think, to a mistaken application of a recent decision of this House in a case Cenlon Finance Co. Ltd. v. Ellwood* I must now address myself to it. We have, then, to suppose that the respondent, instead of being a limited company, was operating its finance company business as an individual and carrying out the same operations as have been carried out here. If one were asked the bare question whether in making up the trading account of such a man it would be right to bring in interest and dividends received on the stocks and shares that he was dealing in, I should think that the answe....
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....h a taxable subject as any other form of income, or for doubting that, for the purposes of income tax as distinct from surtax when they are distributed by a limited company out of a fund of profit that has been taxed in its hands, the proportionate shares of the taxed fund so distributed are not liable to taxation again in the hands of the recipients. The operation of transferring the residue of the taxed fund from the company's hands to the hands of the owners no more creates a fresh accrual of income than does the operation of a trustee paying over to his beneficiary the net amount of the trust income that has borne tax in his hands. Dividends which represent the distribution of a taxed fund are therefore "franked" income so far as concerns any further taxation at the standard rate, that is, the rate at which deduction has been made; while, for the purposes of administering reliefs against tax at standard rate and of assessing to surtax, it is proper to treat the net sum received as grossed up in the way that the statute (Income Tax Act, 1952, s. 184) requires. This account of the status of dividends in the tax system is in line with the analysis offered by Lord Phillimore in....
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....hall allude to this principle later, since it affords, I believe, the answer to the argument of the respondent. Before coming to this, however, it is relevant to ask whether there has ever been a practice of making a stock dealer's tax assessments to Case I of Schedule D on the basis of bringing into account dividends and interest received. The case of Cenlon Finance Co. Ltd. v. Ellwood** contains statements in this House which were evidently made in the belief that such a practice did prevail, but we are all satisfied, I think, that they were due to a misconception. The matter has been looked into carefully since the Cenlon decision was made public, and counsel for the Inland Revenue have assured us that their researches contradict the existence of any such practice. Counsel for the respondent, speaking from an exceptional range of experience, confirmed the novelty of the assumption made in Cenlon**. I think that we must take it that it has been long-established and regular practice to exclude taxed interest and dividends from the computation. The practice with regard to finance companies was so stated in an affidavit which is reported as having been placed before the court....
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....was no misconception and no delusion. Dividends that had borne tax or suffered deduction of tax--I see no difference in this context between the two ways of putting it--before receipt are, to use Lord Dunedin's phrase***, "exhausted as a source of income," and the general principle applied to the construction of the provisions of the Income Tax Code prevents their being brought in again, directly or indirectly, as a subject of taxation in the form of another class of taxable income. It is neither here nor there that in the words of section 127 of the 1952 Act tax is to be charged under Cases I and II of Schedule D on "the full amount of the profits or gains." That has no effect on the principle of computation. The rule of excluding income which has been assessed to tax "under its own title" from insertion as an item in an assessment under Case I of Schedule D was recognised and given effect to by this House in the well-known Salisbury House decision* (rents from land) and again by the Court of Appeal in Thompson v. Trust and Loan Co. of Canada** (interest on Government bonds). The principle is clearly stated in the first case*** in the speeches of Viscount Dunedin and of Lord A....
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....ributed by a company out of a fund of "profit" that had not been taxed in its hands or taxed by way of deduction against the shareholders; and, whatever else can be said about the taxability or non-taxability of these capital dividends in the hands of shareholders (as to which I hope that the question can still be regarded as open), it is at any rate clear that the basic reason for excluding taxed dividends from Case I computations, that they have borne tax already, is exactly what is lacking in these capital dividends, which no one taxes at present at any point. Nothing that I have said, therefore, involves any critical comment on the Cenlon decision* as confined to such dividends. It was, of course, appreciated when it was said that dividends taxed at source ought to enter into the computation of a dealer's trading profits that this would involve taxing the same income twice over, a procedure that is normally regarded as unfair and unacceptable. To avoid the practical consequence of this, however, it was suggested in the Cenlon case* that there was some equitable principle that could be invoked against the revenue which would compel an adjustment of the tax bills on the tw....