Land-dealing company acquires property from members for £6,000 borrowed either from the members themselves or from a bank–Money not applied ‘out of the income of the company,’ surtax direction therefore cannot be served requiring it to be apportioned between the members, there being otherwise no failure to distribute a reasonable part of the company’s income–Taxpayers’ appeal allowed
This was an
appeal by Hanstead Investments Ltd from a decision of Brightman J in the
Chancery Division on March 8 1974 upholding a surtax direction by which £6,000
paid by the company for a portion of the Hanstead Estate, Hertfordshire, was
apportioned between the company’s members, Mr Henry Pelham and Mr Paul Pelham.
Mr A E W Park
(instructed by Allen & Overy) appeared for the appellants, and Mr L Bromley
QC and Mr B Davenport (instructed by the Solicitor of Inland Revenue)
represented the respondent commissioners.
Giving
judgment, RUSSELL LJ said that in 1958 Mr Henry Pelham and Mr Paul Pelham
purchased the Hanstead Estate at an auction for £120,000. It comprised a
mansion, several cottages and many acres of land. In 1959 the taxpayer company
was incorporated to carry on the business of land-dealing. The issued share
capital of the company was £2, which was held by the Pelhams. In 1969 the
company purchased the mansion and the cottages from the Pelhams for £6,000. Two
days later that property was resold for £49,000, the greater part of which was
left outstanding on a five-year mortgage. It was uncertain whether the company
borrowed £6,000 from the bank or remained indebted to the Pelhams for the
unpaid purchase-money. A surtax direction was made against the company under
section 245 of the Income Tax Act 1952 in respect of an accounting period from
August 1959 to April 1962, requiring the £6,000 to be apportioned between the
Pelhams. The company’s appeal to the special commissioners against the
direction to apportion was dismissed on the ground that for the purposes of
section 246 (2) (a) of the Act, the £6,000 was paid by the company otherwise
than out of capital and was therefore to be regarded as being available for
distribution. On appeal by the company, Brightman J upheld the commissioners.
Section 246
(2) read: ‘For the purposes of the last preceding section any such sum as is
hereinafter described shall be regarded as income available for distribution
among the members of the company . . . (a) any sum expended or applied . . .
out of the income of the company . . . (i) in or towards payment for the
business, undertaking or property which the company was formed to acquire. . .
.’ The question raised in the present
appeal was whether, on the facts, the payment of £6,000 made by the company was
within the scope of section 246 (2) as being a sum ‘expended or applied out of
the income of the company.’ Section 245
provided for a surtax direction in respect of the actual income of the company
from all sources for a year or other period of account, deeming it to be the
income of the members, when it appeared to the special commissioners that the
company had not actually distributed a reasonable part of that income within a
reasonable time after the expiration of that period. Section 246 (1) provided
that in determining whether or not there had been a distribution of a
reasonable part of that actual income, regard should be had not only to the
current requirements of the company’s business but also to such other
requirements as might be necessary or advisable for the maintenance and
development of that business. The company’s actual income for the period was,
of course, the profit on the deal and interest on the mortgage less management
expenses and profits tax. Section 246 (2) was designed to deprive a taxpayer
company of some ability to contend that its financial situation made it
reasonable not to make a distribution, or a greater distribution, of the
profits of the period before the expiration of the reasonable time. Subject to
an alternative point taken on the company’s behalf, the £6,000, if expended out
of the company’s income, would come within the description of a sum mentioned
in section 246 (2). And that would mean that that sum would fall to be regarded
as income available for distribution among the members, and not as having been
applied to the requirements mentioned in section 246 (1).
There was
considerable debate as to the meaning of the phrase ‘out of the income of the
company.’ At one time, he (his Lordship)
understood it to be accepted by the Crown that the phrase meant out of the
profits of the company in the sense of the payment being a proper attribution
against its computed profits. Subsequently however it emerged that the Crown’s
contention was that the phrase meant ‘otherwise than out of what may properly
be regarded as capital assets or capital profits of the company.’ But just as ‘income’ in section 245, and in
the earlier part of section 246 (2), referred to profits, so the meaning of
‘out of the income of the company’ meant ‘out of what may properly be regarded
as income profits of the company.’ It
would be strange for the statute to regard a sum as income available for
distribution among members unless it be properly attributable to a disposition
of income profits. The fact was that when the £6,000 was paid there were no
other profits of the company other than that realised on the particular
transaction. Thus it could not be said that the expenditure of the £6,000,
which had necessarily to be deducted from the purchase-price before the profits
could be ascertained, could be regarded in any sense as expended out of that
profit. The commissioners found that unless the £6,000 was embraced by section
246 (2) there had not been a failure to distribute a reasonable part of the
relevant income, because of the company’s poor liquidity position. If they were
wrong in their view that the £6,000 was embraced by section 246 (2), therefore,
the surtax direction should be overset. Brightman
decision of Lawrence J in Morris Securities Ltd v IRC (1940) 23
TC 525. But regardless of whether or not that case was correctly decided, it
did not cover the present one. For in that case the first-acquired property was
retained, and during the appropriate period the company made ample profits from
its trading to cover the relevant payments in respect of the purchase-price. It
was thus clearly permissible to regard those payments as paid out of company
profits. Further, he (Russell LJ) did not agree with the Crown’s contention
that it would be absurd to attribute to the legislature an intention to bring
within section 246 (2) a payment such as that made in the Morris case,
but not that made in the present case. The fact that the decision in one case
and in another might depend upon the incidence of the sequence of events did
not involve absurdity, nor was any reversal of the Morris case implicit.
Accordingly,
the payment or repayment of the £6,000 was not in any sense ‘out of the income
of the company,’ and the appeal should be allowed and the surtax direction
over-set. The alternative contention for the company that ‘property’ in section
246 (2) did not extend at all to such facts as found in this case, where the
property acquired was trading stock, did not have to be decided in the
circumstances. He (his Lordship) was inclined to doubt its validity, but would
not express a conclusion on it.
STAMP LJ and
SIR JOHN PENNYCUICK agreed, and the appeal was allowed. Leave to appeal to the
House of Lords was granted on terms as to costs.
