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British Sugar Manufacturers, Ltd. v. Harris Inspector Of Taxes.
Factual and Procedural Background
The dispute concerned a contractual provision under which certain companies (referred to in the opinion as the Skoda Works and the Corporation) were to receive 20% of a calculated "net profit" as remuneration for services (described as ordinary management or advisory technical work). The central question was whether those payments were a deductible remuneration (a commission payable for services and to be taken into account in ascertaining profits) or were a share of profits payable out of profits after they had been ascertained (and therefore not deductible under the relevant tax rule).
The matter was before an appellate court. The opinion records that the court considered earlier authorities, reserved and considered a second point for which leave to appeal to the House of Lords might have been sought, but ultimately concluded that the decision on the first point covered the whole matter. The opinion concludes with the appellate court's disposition: Appeal Allowed.
Legal Issues Presented
- Whether a contractual payment described as a percentage of "net profits" and payable to parties for services (management/advisory/technical) is in truth a payment of remuneration for services that must be taken into account in ascertaining the company's profits, or whether it is a division of profits payable out of profits after they have been ascertained.
- Whether a payment the amount of which is contingent on or dependent upon profits earned should be treated, for the purposes of Rule 3(l) (applicable to Cases I and II of Schedule D), as an annual payment "payable out of the profits or gains" (i.e., not deductible) or as an expense necessary for earning profits (i.e., deductible).
Arguments of the Parties
Attorney-General's Submissions
- The Attorney-General suggested that the absence of a fixed salary (i.e., that the remuneration was purely commission-based) might affect whether the payment should be treated as remuneration or as a share of profits.
- Regarding a secondary point, the Attorney-General indicated that, if the court's decision on the first point were definitive, leave to appeal would not have been sought; but on the second point the Attorney-General would have sought leave to appeal to the House of Lords because of potential difficulties if the higher court found that the second point did not arise in view of the court's first finding.
The opinion does not contain an extended or detailed record of other party pleadings or a point-by-point account of adversarial argumentation beyond the limited submissions summarised above.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Last v. London Assurance Corporation | Illustrates a situation where a party (policyholder) was treated as having purchased a share in profits; such a purchase denotes a share of profits, not deductible remuneration. | The court distinguished Last on the ground that in that case the arrangement amounted to a purchase of a share of profits. In the present case no purchase of profits occurred; the payments were for services, not a transfer of capital or an acquired share of profits. |
| Union Cold Storage Co. v. Adamson (Adamson v. Union Cold Storage Co.) | Authority for the proposition that where a company obliges itself to make payments contingent on profits, those payments are not, in principle or authority, to be treated as payments "made out of the profits" within the meaning of Rule 3(l). | The court relied on Romer L.J.'s reasoning that there is no principled foundation for treating contingent profit‑dependent payments as payments out of profits; the court found that the same reasoning applies to commission payments set as a percentage of profits. |
| Indian Radio and Cable Communications Co. v. Bombay Presidency and Aden Income Tax Commissioner | Explains the important accountancy distinction that the term "profits" can be used in different senses and that a commission expressed as a percentage of "net profits" is typically calculated on the net profit before deduction of that commission. | The court treated Lord Maugham's passage as dispositive: once it is recognised that "profits" may be used in different senses for different purposes, the apparent difficulty dissolves and supports classifying the commission as a payment to be taken into account in ascertaining profits. |
| Pondicherry Railway v. Madras Income Tax Commissioner | Contains the statement (Lord Macmillan) that "A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits" — used to support that some payments conditional on profits are truly payments out of profits. | The court read Lord Macmillan's observation in context: it applied to a contract that was merely a sum payable out of profits (no services). The court distinguished that factual situation from the present case, where services were rendered and two separate accounting funds existed. |
Court's Reasoning and Analysis
The court's analysis proceeded along these principal lines, expressed in the opinion:
- Characterisation of the clause: The court regarded the disputed provision, when considered in its true nature, as an agreement for remuneration by way of commission — a percentage of "profits" — payable for services to be rendered to the company (ordinary management/advisory/technical services). The court emphasised that such arrangements are common methods of remunerating officers or service providers.
- Meaning of "net profit": The court noted that the term "net profit" in the contract was to be ascertained on a conventional basis agreed between the parties, and not necessarily on the company's normal commercial or income‑tax computation bases. This accountancy aspect mattered to classification.
- Two-account analysis: Central to the court's reasoning was that two distinct "profit" funds had to be ascertained. The first fund was the conventional basis used to calculate the 20% commission payable to the Skoda Works and the Corporation; that fund existed solely for the purpose of determining the commission and was of no concern to the shareholders as a divisible profit. After the commission payment was made (on that first account), a second account would be taken to ascertain divisible profits (which would include adjustments such as depreciation and the commission payments already made). The existence of these separate accounts demonstrated that the commission was payable before the divisible profits were ascertained.
- Distinction from a purchase of profits: The court distinguished cases (for example Last) where the arrangement effectively amounted to a purchase of a share of profits (in which case the payment is not deductible). Here, no cash or capital passed in exchange for a share of profits; services were rendered, and the badge of the contract was remuneration for services rather than acquisition of profit rights.
- Reliance on authority and accountancy principle: The court found particular assistance from (a) Romer L.J.'s reasoning in Union Cold Storage Co. v. Adamson that payments contingent on profits are not necessarily payments out of profits for Rule 3(l) purposes, and (b) Lord Maugham's explanation in Indian Radio and Cable Communications Co. v. Bombay Presidency that the word "profits" may be used in different senses — notably that a commission stated as a percentage of "net profits" ordinarily refers to net profits before deduction of the commission itself. Linking this accountancy perspective with the two‑account structure of the contract, the court concluded that the commission was a remuneration to be taken into account in ascertaining profits.
- Consideration of contrary language: The court considered Lord Macmillan's statement (in Pondicherry Railway) to the effect that a payment out of profits conditional on profits being earned cannot be described as a payment to earn profits, but read that passage as addressing a different factual class (a simple sum payable out of profits) and therefore not binding in the present circumstances where services were involved and the contract produced two distinct profit accounts.
- Concurrence of the other judges: Romer L.J. agreed, framing the central question as whether the payment was a mere division of profits or a payment the amount of which was ascertained by reference to profits. He concluded the payment was necessary for earning the company's profits and thus a legitimate deduction. Mackinnon L.J. emphasised the ambiguity of "profits" and agreed that the payment was of the character to be taken into account in ascertaining annual profits for assessment.
Holding and Implications
APPEAL ALLOWED.
Holding (core ruling): The appellate court held that the contractual payments in issue were properly characterized as remuneration (a commission for services) the amount of which was ascertained by reference to a conventionally computed "net profit" and therefore were payments to be taken into account in ascertaining the company's annual profits for assessment under Schedule D (i.e., legitimate deductions), rather than being a share of profits payable out of profits after the event.
Implications: The direct consequence is that, on the facts and construction before the court, the 20% commission payments to the Skoda Works and the Corporation were to be treated as deductible expenditures necessary for earning the company's profits for tax assessment purposes. The opinion places the decision within established categories and does not purport to lay down a sweeping new principle beyond applying existing authorities and accountancy reasoning to the contractual facts; the court explained and distinguished contrary authority on its facts rather than announcing a novel rule.
, but for the authorities, would clearly himself have taken is the right view. It appears to me that, when the true nature of this provision is appreciated it is nor possible to avoid the conclusion that it is an agreement for remuneration by way of a commission representing a percentage of "profits" for services to be rendered to the company; in other words, it is nothing more or less than a very common type of agreement under which officers of companies are remunerated by a commission on "profits", which after all is simply a share of "profits," provided that the word "profits" is construed in the right sense. Some suggestion was made by the Attorney General that the absence of a fixed salary in addition to commission affected the matter. I am unable to see that. I can see no reason at all in principle why a contract providing for remuneration by commission and nothing else should not produce the result that the sum payable under it to the employee is a proper deduction.
Now, the first matter to be observed in this case I think, is the nature of the work that is being done. That one may succinctly describe as ordinary management work or ordinary advisory work in respect of technical matters. The next point to observe is that what is referred to as "net profit" is a figure to be arrived at up on a conventional basis, not the basis upon which the company would ascertain its profits for commercial purposes or the basis upon which it would ascertain its profits for income-tax purposes, although, speaking for myself, I think that the latter consideration is not one of any importance. But it is an important factor to be considered (although not necessarily in any individual case conclusive) that the fund of so-called profits, to 20 per cent. of which the companies are to be entitled for their services, is a fund ascertained by means of a conventional account between the parties.
Now bearing all those things in mind, the question arises : on which side of the line does the case fall ? I quite accept the proposition that there is a line between a contract for payment of a share of profits simpliciter and a payment of remuneration which is deductible in truth before the profits divisible are ascertained, and that line in some cases may be very difficult to draw. The well-known case of Last v. London Assurance Corporation is a very good example of that when the division of judicial opinion upon it is considered, but the reason why Lasts Case fell upon the side of the line that it did, appears, I think, from the judgment of LORD BLACKBURN who says this, speaking of the policy-holder (55 L.J.Q.B., at p. 94; 10 App. Cas. at p. 444; Tax Cas., at p. 124) :
"If he dies before the quinquennial period arrives he gets nothing but if his policy is still in force he has, I cannot but think purchased a share in the profits, if any, earned during those five years."Now that was what in Lasts Case had happened. The policyholder was treated as having purchased a share of profits. If a person purchases a share of profits, of course the profits paid to that person cannot be deducted; that is quite obvious.
Now in the present case, there is nothing approaching a purchase of a share of profits in that sense. It is not cash that passes in exchange for these profits, it is services; and the badge of such contract is remuneration for services, and therefore he first thing that this remuneration would certainly not be is a share of profits purchased by the employee. Again, I quite accept the proposition that the mere circumstance by itself that services are rendered may not be conclusive. I can conceive of a case where a person contributes to some sort of joint adventure services, while others contribute perhaps capital, land, plant, and goods, arranging between themselves (it may be something short of a partnership) that nobody shall get anything until the pool of profits is ascertained, and then they shall divide it up between them in specified proportions. That, seems to me would be a real agreement for division of profits, because there would be one profit fund only. There would not be two "profit" funds to be ascertained for different purposes. There would be one profit fund, and nobody would have any interest in anything until that profit fund was ascertained and fell to be divided; but in the present case that is not the fact. In the present case there are two funs of so-called profits which come into the picture. The first one is the fund which has to be ascertained for the purpose of calculating the 20 per cent. In that fund, as such, the persons entitled to the profits of this company, namely the shareholders, have no concern. It is used for the purpose, and for the purpose only, of ascertaining what is to be paid to the Skoda Works and to the Corporation. Now when that amount has been ascertained, that fund has ceased to have any usefulness at all, and it then becomes necessary to ascertain what are the divisible profits, and for that purpose, to take another account, which not only would bring in depreciation, but would also take into account the sum that had been paid out to the Skoda works, and the Corporation upon the taking of the first account. It seems to me that the circumstance that those two accounts have to be made out throws a very clear light upon the real nature of this transaction, and, looking at the clause in question as a whole, it seems to be clear beyond any reasonable doubt that the agreement is merely an agreement under which, before ascertaining the divisible profits of this company at all, the Skoda Works and Corporation are to receive upon a particular conventional basis a commission sum as remuneration for their services. When that has been said, it appears to me that it brings the case within a very familiar category.
Various authorities have been referred to. Speaking for myself I find the greatest assistance from two passages, one of them a passage in the case of Union Cold Storage Co. v. Adamson, where Romer L.J., said (144 L.T., at p. 151; 16 Tax Cas., at p. 328) that, in order to succeed in that case the Crown would have had to establish the following proposition : "That where a company, for the purpose of enabling it to carry on its trade and earn profits in its trade, places itself under an obligation to make money payments, the amount of which is dependent upon the profits earned, or the payment of which is contingent upon certain profits being earned, payments made in discharge of that obligation are payments made out of the profits or gains of the company, within the meaning of Rule 3(l)." He added : "In my opinion, for that proposition there is no foundation at all in principle or on authority." In the case that was being dealt with there the obligation to make the payment was dependent upon the profits earned, but it seems to me that the reasoning and the expressions of ROMER L.J., equally apply to the case where the payment to be made is a commission on or a percentage of profits earned.
The other passage is in the judgment of the Privy Council delivered by Lord Maugham in the case of the Indian Radio and Cable Communications Co. v. Bombay Presidency and Aden Income Tax Commissioner. That was a case into the facts of which I need not go, but it is important as containing a reference to the particular phrase in an earlier case which affected the mind of FINLAY, J., in the present case. That case having been brought to the attention of the Board in Indian Radio and Cable Communications Co. v. Bombay Presidency and Aden Income Tax Commissioner, Lord Maugham said this (1937 I.T.R. 270 at p. 277) :
"It may be admitted that, as Mr. Latter contended, it is not universally true to say that a payment, the making of which is conditional on profits being earned, cannot properly be described as an expenditure incurred for the purpose of earning such profits. The typical exception is that of a payment to a director or a manager of a commission on the profits of a company. It may, however, be worth pointing out that an apparent difficulty here is really caused by using the word profits in more than one sense. If a company, having made an apparent net profit of Pounds 10,000, has then to pay Pounds 1,000 to directors or managers as the contractual recompense for their services during the year, it is plain that the real net profit is only Pounds 9,000. A contract to pay a commission at 10 per cent. on the net profits of the year must necessarily be held to mean on the net profits before the deduction of the commission, that is, in the case supposed, a commission of the Pounds 10,000."
That passage, in my opinion, contains sufficient to dispose of this case, and if I may link it up, as I understand it, with what I said a moment ago about the two accounts, those are, I think what may be called the accountancy aspect of the two different senses in which the word "profits" is used in these cases, as explained by Lord Maugham. Once you realise that as matter of construction the word "profits" may be used in one sense for one purpose and in another sense for another purpose, I think you have the real solution of the difficulties that have arisen in this case.
The passage relied upon by FINLAY, J., which he considered constrained him against his own opinion to decide as he did, occurred in the judgment of the Privy Council delivered by Lord Macmillan in the Pondicherry Railway v. Madras Income Tax Commissioner (L.R. 58 Ind. App., at p. 251) : "A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point, and the revenue is not concerned with the subsequent application of the profits." It is to be observed that Lord Macmillan in that paragraph was quite clearly using the word "profits" in one sense and one sense only, he was using it in the sense of the "real net profit" to which Lord Maugham referred. That he was doing that is, I think, abundantly clear when the nature of the contract that is in question is considered, which was merely a contract under which a percentage of profits was payable by the railway company to the French Government. There was no question of services or anything of that kind in the case, it was merely a sum payable out of profits. I do not find myself constrained by that expression of opinion, because it must be read, as lord Macmillan said in Adamson v. Union Cold Storage, Co., (146 L.T., at p. 179; 16 Tax. Cas., at p. 331), in relation to the particular subject-matter with which he was dealing.
That disposes really of the whole appeal because precisely the same point arises on the other assessments. But there is a further point in regard to them on which I feel that I ought to express an opinion, as it was fully argued.
The Attorney-General. - Will your Lordship allow me (I know that it is very exceptional) to make a submission with regard to this second point. So far as the first part of your Lordships judgment is concerned we should not have made any application for leave to appeal. So far as the second point is concerned we should have regarded it as a proper matter to ask your Lordship for leave to appeal. Your Lordship will appreciate the difficulties that might arise if the House of lords said that this point did not really arise in view of your Lordships finding on the first part of the case.
Their Lordships conferred.
Greene, M.R. - We all think in the circumstances that as the decision which I have given, with which the other members of the Court will, I understand, agree when they come to deliver their judgments, covers the whole matter, there is no necessity to go on and deliver judgment on the second point. Of course, it will not be taken from that by anybody concerned that it means that we are necessarily in agreement with the decision of the Court below.
ROMER, L.J. - I agree with the judgment that has been delivered by the Master of the Rolls upon the first point. It appears to me that in all cases similar to the one with which we are dealing to-day the real question is this : Is the payment that has to be made by the trader under the contract in question a mere division of profits with another party or is it a payment to the other party, the amount of which is ascertained by reference to the profits ? The question whether particular case falls on one side of the line or the other is very often one of extreme difficulty. How difficult it may be is apparent from the fact that in the case Last v. London Assurance Corporation, four learned Judges were of opinion that the payment there fell on one side of the line and four learned Judges were of that it fell on the other. For myself in this case I can feel no doubt. The payment that has to be made in this case, is in my opinion, a payment that is made, the amount of which has to be ascertained by reference to certain profits of the company ascertained in a particular way. The payment is a payment necessary for the purpose of enabling the company of the trader to earn the profits of its trade, and therefore it is a legitimate deduction from its profits when ascertained for the purpose of assessment under Schedule D. I think the conclusion is very much assisted by the consideration to which the Master of the Rolls has called attention, that in this case the payment is by reference to profits which are not the profits which would be divisible between the company and any body else interested in those profits. I agree, therefore, that this appeal should be allowed.
MACKINNON, L.J. - I agree. Rule 3(l) of the Rules applicable to Cases I and II of Schedule D, provides that in assessing the annual profits or gains no deduction shall be allowed or made for any annual payment - not any annual payment simpliciter, but any "annual payment payable out of the profits or gains." The whole question in this, as in other cases, is whether this, which is an annual payment, is an annual payment to be taken into account in order to ascertain the profits, or is it an annual payment payable out of the profits after they have been ascertained ? I think the true facts of this case are that it is of the former character. The difficulty in the case arises largely because of the necessary ambiguity in the word "profits" and the fact that in this agreement "profits" as a word does appear; but "profits", as I think, quite clearly of a different description from the annual profits or gains with which one is concerned in assessing the income-tax. That ambiguity again arises and causes a difficulty in that passage that was quoted from Lord Macmillans opinion in the Privy Council. He said (L.R. 58 Ind. App., at p. 251) : "A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits". "Profits" there means a certain thing, and that is a truism; but it would be equally a truism to enunciate in this sentence : "A payment necessarily made in order to earn profits cannot properly be described as a payment out of profits." Both those sentences are ambiguous until you clearly ascertain in what sense you are using the word "profits" and to what it is referable. In this case I think this annual payment was not one payable out of profits after they had been ascertained, but one to be taken into account in ascertaining what the annual profits were.
Appeal Allowed.
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