Properties sold by Church Commissioners in consideration of annual rent charges for period of 10 years–Much to be said economically, but not legally, for the view that the consideration for such a sale must contain two elements, a capital element and an income element–Legally, payments made under such an arrangement are taxed as income–Deductions at source therefore recoverable in full by Church Commissioners under section 447 (1) (a), Income Tax Act 1952
This was an
appeal by the Commissioners of Inland Revenue from a decision of the Court of
Appeal holding that the Church Commissioners for England were entitled to
recover under section 447 (1) (a) of the Income Tax Act 1952 sums deducted as
income tax by Land Securities Investment Trust Ltd when making payments to the
Church Commissioners under a series of rentcharges created in 1960.
D C Potter QC
and D K Rattee (instructed by the Solicitor of Inland Revenue) appeared for the
appellants, and M P Nolan QC and S J L Oliver (instructed by Herbert Smith
& Co) represented the respondents.
In his speech,
LORD WILBERFORCE said that the respondents were formerly the owners, in some
cases for freehold, in others for leasehold interests, of a number of
properties which were let or underlet to Land Securities Investment Trust Ltd
(‘Land Securities’) on long leases. The rents payable by Land Securities to the
respondents came, in aggregate, to £40,000 a year. By an agreement dated
January 5 1960 the respondents agreed to sell these properties to Land
Securities in consideration of what were described as yearly rentcharges
issuing out of the properties for a period of 10 years from April 1 1960. There
was also a covenant by Land Securities to pay the amounts of the rentcharges.
The rentcharges came, in all, to £96,000 a year. It was not disputed that the
object of this was to enable the respondents, while maintaining their current
income at £40,000 a year during the 10 years, to accumulate the balance in each
year so that at the end of the period they would have a capital sum which would
yield them at least £40,000 in perpetuity. On the other side, Land Securities
would secure capital assets which would improve the value of their investments.
On paying the rentcharges Land Securities deducted income tax in accordance
with the Income Tax Act 1952, section 177 (1). There had been litigation as
regards Land Securities’ own tax position, but the present appeal was concerned
solely with the tax position of the respondents. To the extent that income tax
was properly deductible by Land Securities, the respondents claimed to be
entitled, as a charity, to recover it from the appellants under section 447 (1)
(a) of the Act of 1952. The appellants refused relief under the section, but
the special commissioners gave it, and Megarry J and the Court of Appeal had
endorsed that decision. The Crown now came to their Lordships’ House.
There were two
arguments advanced on the Crown’s behalf, one general and one particular on the
individual facts of this case. The general argument ran: ‘Where a capital asset
is transferred, or a capital obligation is discharged, or a capital payment is
made, in consideration of a series of cash receipts of fixed amount over a
fixed period so that the total debt may be immediately calculated, then those
cash receipts are in the hands of the recipient partly income and partly
capital, whether the parties call the series of cash receipts ‘rent’ or
‘annuity’ or ‘annual sums’ or ‘rent charges’ or ‘instalments,’ and whether the
payments are secured or unsecured.’ This
general rule was, on the face of it, extremely reasonable. Nothing more
apparently correct, just and in accordance with sound principle could be laid
down than that when payment of the purchase price for a capital asset was
spread over a number of years, each payment should be treated as containing a
capital element and an income element, the latter reflecting the deferred
character of the payment. That such a rule had much to commend it was
cautiously recognised by Lord Greene in 1941 as ‘simple and perhaps not unjust’
(Southern-Smith v Clancy [1941] 1 KB 276 at 285). But as clearly
as it appeared to be consistent with simple justice, so, equally clearly, was
it inconsistent with our tax law as it had developed and as it had been
applied–to the benefit, incidentally, of the Revenue, which was now arguing for
a change.
English tax
law had consistently taxed as revenue periodical payments of the kinds
enumerated in section 177, in spite of the fact that they might be payments for
wasting assets, ie assets the capital value of which was to disappear after a
time, and without any distinction (such as the Revenue sought to draw here)
between perpetual payments or payments for an indeterminate period such as the
life of a person, and terminable payments in the sense of payments for a fixed
term. The principle of this was explained with elegance and authority in Coltness
Iron Co v Black (1881) 1 TC 287, both in the Court of Session and in
the House. It was immaterial for income tax purposes that for accountancy
purposes payments in respect of (for example) wasting assets might be treated
as containing a capital element. It was immaterial that, in accordance with
equitable principles or with express provisions in the Settled Land Act 1925
(see section 39), a proportion of a terminable payment should have to be put
aside to capital. The Church Commissioners were an ‘exempt charity,’ but if
they were not, they would be obliged by sections 29 and 39 of the Settled Land
Act 1925 to segregate a capital element in a terminable payment and to treat it
as capital. Nevertheless this would be irrelevant for taxation purposes. It was
immaterial that a series of payments made to a beneficiary out of a trust fund
should be shown to have been made out of the capital of the trust: the whole of
these payments might still be taxable as income (Brodie’s Will Trustees
v IRC (1933) 17 TC 432; Jackson’s Trustees v IRC 25 TC
13). In other words, except in particular cases where a different rule was
stated, all payments falling within the charging words were prima facie taxable
as income notwithstanding that, as a matter of accountancy or prudence or trust
administration, some part ought to be treated as capital.
He (his
Lordship) said prima facie, because there were certain cases in which
the courts had held that although the
on the payment, or not wholly chargeable. An example was where there was a sale
for a consideration represented by a principal amount which was payable by
instalments. The distinction between such a case and that where the sale was for
an annuity or a rentcharge had been recognised by many authorities, eg in this
House in IRC v Wesleyan & General Assurance Society [1948] 1
All ER 555 at 557 per Viscount Simon, approving the much-quoted passage from
the judgment of Lord Greene MR in the Court of Appeal ([1946] 2 All ER 749 at
751). He (Lord Wilberforce) did not think that the Revenue could succeed on the
general argument without destroying this dichotomy. On general logical grounds,
and perhaps on considerations of an economic character, there might be much to
be said for a rule which recognised the existence of an interest element in all
deferred capital payments. But, illogical or not (and the consequences of
rejecting the dichotomy might introduce other illogicalities), the distinction
was too clearly and firmly rooted in the income tax law to be displaced,
except, in selected cases, by legislation. And it had been, if not without
difficulty, at least with fair consistency, applied by the courts. Coming down
to the particular argument presented for the Revenue on the facts of the
present case, the essential feature of the parties’ negotiations and of the
ultimate bargain, as shown by the documents, was that Land Securities did not
wish, on any account, to pay a lump sum for the properties. This was so found
in terms. The Church Commissioners, on their side, wished to maintain their
existing income by rentcharges for a longer period. The figure of £720,000 that
had been referred to was not an agreed purchase-price, or even an agreed valuation.
It was, as he (his Lordship) understood it, simply a checking figure in the
calculations, worked out on the basis of 18 years’ purchase (corresponding to 5
1/2 per cent) of the existing rents of £40,000. The bargain was always thought
of in income terms, and was concluded in income terms, and there was nothing in
the documents which gave to the transaction, or to any element in it, a capital
character. The appeal should be dismissed.
Agreeing, LORD
MORRIS OF BORTH-Y-GEST said that in his view two questions now arose. The first
was whether in income tax law it was possible to regard annual payments of
fixed amounts over a fixed period as being of an income nature in cases where
parties had agreed that such payments would be made in exchange for the transfer
of a capital asset. If that was in law possible, the second question was
whether on a consideration of all the evidence in the present case the payments
that were made were in fact of an income nature. In considering questions of
the kind, it should be borne in mind that unless by some principle of law an
annual payment must be given a particular characterisation, it would be
surprising if the result had to be reached that the ‘real nature’ of an
arrangement was wholly different from that which the parties to it honestly
intended and wished and truly and faithfully thought that they had made. Nor
need a search for the real nature of an arrangement be deflected by considering
what would be the real nature of some alternative arrangement that might have been
made but was not. The real nature of a transaction was not automatically
changed merely because its net result was the same as that of a different
transaction. In IRC v Wesleyan & General Assurance Society
(1946) 30 TC 11 Viscount Simon at p 25 pointed out that:
. . . a
transaction which, on its true construction, is of a kind that would escape
tax, is not taxable on the ground that the same result could be brought about
by a transaction in another form which would attract tax.
As to the
first of the two questions raised above he (his Lordship) saw no reason in
principle to doubt that it was possible to transfer a capital asset on the
terms that in return annual payments of fixed amounts would be made, which
payments would be entirely of an income nature. It was accepted that such
payments would be entirely of an income nature if they were made perpetual, and
he saw no reason in principle why it was not possible for them also to be of an
income nature if they were to be made for a fixed period. The passages from the
judgment of Romer LJ in IRC v Ramsay and of Lord Greene MR in IRC
v Wesleyan & General Assurance Society (in the years 1935 and 1946
respectively) which were quoted in the judgment of the Court of Appeal showed
that both those learned judges thought that of two possible methods of selling
property one could be by way of making annual payments of fixed amounts for
fixed periods, which payments would be of an income nature. When the latter of
the two cases was before the House (see 30 TC 11), and when Viscount Simon
quoted Lord Greene’s words (though with the omission of the precise
illustration and the figures used by Lord Greene), he indicated accord with the
principle that Lord Greene had enunciated. This clearly appeared from the
following words:
As the Master
of the Rolls said in the present case: ‘In dealing with income tax questions it
frequently happens that there are two methods at least of achieving a
particular financial result. If one of those methods is adopted tax will be
payable. If the other method is adopted, tax will not be payable. The net
result from the financial point of view is precisely the same in each case, but
one method of achieving it attracts tax and the other method does not.’
In Secretary
of State in Council of India v Scoble [1903] AC 299 it was not
disputed that certain payments made under a contract embraced both capital and
interest. There was the purchase of a railway at a price which was determined
and became payable; an option provided for by contract was exercised; pursuant
to such option, instead of a payment of the gross sum of the determined price
there was to be payment of what was called an annuity in the calculation of
which there was to be a rate of interest ascertained as provided for by the
contract. It was a clear case where what was called an ‘annuity’ embraced both
principal and interest. Only the interest was of an income nature, and only the
interest was taxable. It was apparent on the face of the contract that part of
the annuity was by way of capital repayment. The present case was wholly
different from Scoble’s case. It was very different also from Vestey
v IRC [1962] 1 Ch 861. In that case an agreement provided for the sale
of shares for the sum of £5,500,000. It provided that such purchase price was
to be paid without interest by yearly instalments of £44,000 for the next 125
years; if there was default in the payment of an instalment all the unpaid
instalments became payable. The taxpayer claimed that the annual sums of
£44,000 were capital sums (as instalments of the purchase price) and that no
part of such sums was to be included in computing his total income. The special
commissioners decided that they should consider the surrounding circumstances.
One circumstance was that the shares sold for £5,500,000 were worth £2,000,000;
another was that, as accountants had advised at the time of the contract, if
£2,000,000 was to be paid by annual instalments over 125 years with interest on
the unpaid balance at 2 per cent per annum such instalments would approximate
to £44,000 per annum. The special commissioners found that the annual payments
contained an interest element. On the facts of the case, that was perhaps a
very reasonable inference, and Cross J upheld the special commissioners.
For the
reasons stated, he (Lord Morris) considered, as already indicated, that the
answer to the first question was in the affirmative. As to the second question,
it was clear that the only contract that was made was that of January 5 1960.
The agreement of that date did not provide for any individual purchase-price
for any one of the properties, and did not provide for any overall
purchase-price. The payments to be made were the seven separate annual payments
for the seven properties. The documentary evidence showed that discussion and
negotiations concerning the possible purchase by Land Securities of the
freehold and leasehold properties extended over many months prior to January
1960. As far back as about the year 1956 the Church Commissioners had decided
that they would sell all their leasehold properties where the leases had more
than 50 years to run. Some of the properties were offered to the chairman of
Land Securities, but he was not prepared to buy. Later, however, the chairman
said that he was prepared to purchase the properties in exchange for
rentcharges but would on no account buy them for a lump sum. So the Church
Commissioners had to consider whether they were agreeable to proceedings on
that basis. They were an exempt charity, and did not need the consent of the
Charity Commissioners to dispose of their property: they had all the powers of
a freeholder. On a consideration of the proposed basis, the Church
Commissioners were not averse to it provided that the rentcharges were enough
in amount both to maintain during the period of the rentcharges the income
which they derived from the properties and also to provide a sinking fund
which, by the end of the period of the rentcharges, would yield a continuing
income.
It was
manifest that the discussions between the Church Commissioners and Land
Securities might have resulted in any one of various possible agreements. What
had to be considered was what, after all the discussions and correspondence,
they did actually do and what agreement they actually made. He (his Lordship)
found nothing to suggest that the parties made any agreement other than that of
January 5 1960, and nothing to suggest that the true nature of their agreement
was to be determined other than upon a consideration and interpretation of that
written agreement. The true legal position was that the parties made that
agreement and no other. He (Lord Morris) agreed with the conclusion of the
Court of Appeal that: ‘The transaction here was nothing more or less than the
replacement of one income-producing property, namely, the reversion, for
another income-producing property, namely, the rentcharge allied with the
covenant to pay its amount.’
Accordingly, the appeal should be dismissed.
LORD
KILBRANDON said that he agreed with the speech to be delivered by Lord Fraser
of Tullybelton, and would accordingly dismiss the appeal.
LORD SALMON
said that he entirely agreed with the speech of Lord Wilberforce, and for the
reasons there stated would dismiss the appeal.
LORD FRASER OF
TULLYBELTON said that counsel for the appellants had argued that if the label
‘annuity’ in section 177 (1) was not conclusive as to the income character of
the payments, the label ‘rentcharge’ was equally inconclusive. He (his
Lordship) was not sure that he would go the whole way with that argument. It
seemed that the words ‘annuity’ and (even more) ‘annual payment’ were wide
enough to be fairly described as ambiguous as to the capital or income nature
of the payments, but that ‘rentcharge’ and some of the other words used in
section 177 (1) were much more strongly suggestive of income. For instance, it
was difficult to imagine that payments of ‘feu duty’ could ever be capital. But
however that might be, the effect of section 177 was that the kinds of payment
there described, including rentcharges, were at least prima facie of an
income character. Assuming, nevertheless, that rentcharges could, like
annuities, lose their prima facie character by reference to the
transaction as a whole, yet he (his Lordship) did not think that the
transaction in this case led to that result. In the formal agreement all the
indicia pointed towards the payments being of an income nature. The
consideration was stated to be the rentcharges supported by the personal
covenant of the purchasers, and there was no mention of a capital sum. It
happened that the total amount of the rentcharges which were payable for 10
years was immediately obvious and hardly even required to be calculated, but
that was no reason for treating the contract as if it had provided for payment of
a capital sum by instalments when it did not do so. The relatively short period
for which the rentcharges were payable was certainly consistent with their
being partly capital, but it was not enough by itself to lead to that
conclusion. The transfers of the separate reversions giving effect to the
agreement were exactly in line with its provisions and contained nothing to
show that the rentcharges were not income. The appeal should accordingly be
dismissed.
