Inland Revenue Commissioners v. Lawrence, Graham & Co.

, will deliver the judgment of the Court.

ROMER, L.J., - This appeal comes before comes before us in the following circumstances : By a mortgage dated January 13, 1925, a reversionary interest was assigned to the Legal and General Assurance Society (hereinafter referred to as "the society) to secure a sum of Pounds 10,000. The deed contained a covenant by the mortgagor to repay the sum advanced and also a covenant to pay half yearly such a rate of interest thereon that after deduction of income tax from each periodical payment there would remain a net sum equivalent to interest for the same period on the principal money for the time being ruminating due at the rate of 5 1/2 per cent. per annum, reducible on punctual payment of 4 1/2 per cent. The mortgage also provided in Clause 5 (B) that in case before the death of the survivor of the two life tenants (therein named), on whose deaths the reversions were expectant "any interest on the principal money hereby secured or on any accumulations of interest arising under the present provision and added to principal money should be paid one any half yearly day hereinbefore appointed for payment of interest or within thirty days after such half yearly day then from and after such default in payment and until the death of the survivor of the two life tenants (but without prejudice to the right of the society to require payment of the principal moneys and interest and accumulations of interest hereby secured) the sum due in respect of the half years interests unpaid shall be converted into and become principal money as from the half yearly day on which it becomes due and be added to the principal money hereby secured and shall carry interest at the rate aforesaid from the half yearly day on which such half years interest became due and the interest upon all sums so converted into principal money shall be payable on the half yearly days aforesaid but so that all interest unpaid on the original principal money under this present provision half yearly rest and the accumulated fund as well as the original principal sum hereby secured and the interest on such fund and sum shall constitute a charge upon the premises hereby mortgaged and the premises hereby mortgaged shall not be redeemed except upon payment of all principal moneys hereby secured and all interest the accumulations made as aforesaid of interest on such principal money and accumulations."

By two deeds of further charge dated December 14, 1926, and July 4, 1928, respectively, further advances were made by the society to the mortgagor bringing the total sum advanced up to Pounds 25,500. Except that in the case of latter of these two deeds the net rate of interest was Pounds 5 12s. 6d. per cent. per annum, reducible punctual payments to Pounds 4 12s. 6d. per cent. the further advances were made on precisely the same terms as applied to the original advance.

Default was made by the mortgagor in paying the half yearly interest due on April 15, 1939, and all the interest that fell due after that date down to January 10, 1932. Such interest was accordingly added to the principal money under the provisions of clause 5 (B) of the mortgage deed of January 13, 1925, which provision had been incorporated in the deeds of further charge. The amount so added to the principal was the net amount of the interest calculated at the lower rates mentioned in the deeds after deducting therefrom income tax at the appropriate rate. The total amount so added to the principal sum of Pounds 25,000, calculated to January 10, 1932, was Pounds 2,378 19s.

In the meantime, by deed dated October 14, 1929, the mortgagor had created a second mortgage on the reversionary interest to secure a principal sum advanced by a second mortgagee and interest thereon as therein mentioned.

By deed date March 14, 1932, the society, in exercise of their power of sale as mortgagees, assigned the reversionary interest to a purchaser for the sum of Pounds 30,500. Of this sum it was agreed that Pounds 25,500 should remain on mortgage, with the result that, upon completion of the sale, a sum of over Pounds 6,000 representing the balance of the purchase money with certain interest thereon became payable by the purchaser. It was not, however paid to the society but to the respondents, Messrs. Lawrence, Graham & Co., as the societys solicitors. The respondents thereupon paid the society the sum of Pounds 2,378 19s. and a further sum resenting net interest accruing to the society but not yet added to capital, and after paying the costs of the sale paid the balance of the money received from the purchaser to the second mortgagee. The sum representing net interest accruing under the societys mortgage and not added to capital was less that the interest paid by the purchaser on his purchase money and this latter interest had been paid by the purchaser after deducting income tax thereon. Moreover, as already stated the interest that had been added to the principal money due to the society was net interest only, that is to say, the gross interest after deduction of the tax.

In these circumstances it would not at first sight appear that the society, and still less the societys solicitors, could be assessed to income tax in respect of any of the money received by the society out of the proceeds of sale their mortgage security. An assessment was nevertheless made upon the solicitors for the year 1931-32, it being sought to justify such assessment under the provisions of rule 21 of the General Rules applicable to All Schedules of the Income tax Act, 1918, amended by Section 26 of the Finance Act, 1927.

That rule, so far as is material is in these terms : "(1) upon payment of any interest of money... charged with tax under Schedule D... not payable or not wholly payable out of profits or gains brought into charge, the person by or through whom any such payment is made shall deduct there out a sum representing the amount of the tax thereon at the rate of tax in force at the time of the payment.

"(2) Where any such payment as aforesaid is made by or through any person, that person shall forthwith deliver to the Commissioners of Inland Revenue, for the use of the Special Commissioners, an account of the payment, or of so much thereof as is not made out of profits or gains brought into charge, and of the tax deducted out of the payment or out that part thereof, and the Special Commissioners shall assess and charge the payment of which an account is so delivered on that person.

"(2-A) The Special Commissioners may, where any person has made default in delivering an account required by this Rule, or where they are not satisfied with the account so delivered, make an assessment according to the best of their judgment...."

It is not necessary for the purchases of this judgments to state the precise amount of the assessment or the way in which it was calculated; for the calculation was complicated by the fact that credit was given for certain profits and gains of the mortgagor that had been brought into charge and by the payment of interest on the purchase money. But assuming, for the sake of simplicity that these complications did not exist, the contention on the part of the Crown can be stated as follows : when the same of Pounds 2,378 19s. was paid to the society out of the purchase money there was a payment of interest, within the meaning of rule 21, not payable out of profits or gains brought into charge; the respondents were person by or through whom such payment was made, and are therefore liable to be assessed in an amount arrived at by "grossing" the said sum.

The respondents in due course appealed against the assessment and the appeal was allowed by the Special Commissioners. They held, purporting to follow a decision of this Court and two decisions of Singleton, J., to which we refer later, that the interest was, or must be deemed to have been, paid by the mortgagor at the respective dates when it was added to the capital out of fresh advances made to him by the society for that purpose and that, to this extent there was no payment of interest when the property was sold. They accordingly discharged the assessment. They were however of opinion, in case they were wrong in holding that the interest had been paid by the mortgagor treating again the complications above referred to as non existent - (1) that the society were paid the interest by the respondents out of the purchase money; (2) that the society received it under deduction of tax; (3) that the respondents were the persons through whom the interest was paid to the society; and (4) that the respondents having deducted tax from the interest were liable to account for the tax so deducted.

The case was then taken by way of appeal to Lawrence, J., who affirmed the decision of the Commissioners that the interest had been paid by the mortgagor, holding himself bound by the three cases which the Commissioner had purported to follow. He expressed no opinion upon the liability of the respondents to assessment should it be held that the interest had not been paid by the mortgagor.

From that decision of Lawrence, J., an appeal has been taken to this Court and now falls to be decided.

For the purpose of our decision it becomes necessary, in the first place, to consider the case on which the Commissioners and Lawrence, J., relied.

The first of these is Inland Revenue Commissioners v. Holder. That was a case in which a Company had been allowed an overdraft by its bankers, on which overdraft the bank were entitled to charge interest. In accordance with the usual practice of bankers the balance of principal and interest was struck at the end of each half year and the aggregate sum was introduced as the first item in the subsequent half yearly account, and interest calculated upon it. In other words the company was charged compound interest. In these circumstances this Court held that the bank must be regarded as having made, each half year, an advance to the customer of a capitalism equal in amount to the interest then falling due which sum had been applied by the customer in paying that interest. There had been no express agreement between the parties as to the charging of compound interest by the bank. The bank, in charging it, had merely followed the ordinary practice of bankers, and the customer had acquiesced in their doing so. But that practice of bankers is an old one dating back to long before the repeal of the usury laws, and could not, therefore, have been legal unless it was consistent with those laws. Now before the repeal of those laws a contract to allow the charging of compound interest was illegal. The legality of the practice of bankers was, however, upheld by the Courts by treating the bank as making a fresh advance to the customer at the end of each year or half year as the case might be. See, for example, Clancarty (Lord) v. Latouche. There is nothing contrary to the usury laws in such an arrangement. See Bevan Ex parte. It is plain that upon the repeal of those laws an agreement to pay compound interest became lawful. In Holders Case, however, there was no agreement to pay it. The bank had merely purposed an old practice of bankers upon which an interpretation had been put by the Courts. The fact that this had been done at the time when the laws against usury were in force appeared to this Court to be immaterial. The practice continued after the repeal of those laws and the repeal could not affect the nature of the practice.

But a stipulation in a mortgage deed for payment of compound interest stands upon a different footing. Before the repeal of the usury laws such stipulation would have been illegal, except perhaps in the case of a mortgage reversionary interest, in which case there is some ground for thinking that even in those days it would have been supported. (See Howard v. Harris, 1 Vern., at p. 194). The question whether since the repeal of the usury laws effect would be given to such a stipulation in a mortgage, not being one of a reversionary interest, has caused some difference of judicial opinion. The matter is elaborately discussed on Coote on Mortgages (7th edition, Vol. 1, pp. 139-143), but need not be discussed here. For, even if such a stipulation would still be ineffectual as between mortgagor and mortgagee if the former should choose to dispute it, the difficulty would not be got over by treating the stipulation as one that provided for fresh capital advances being made by the mortgagee from time to time. The stipulation would not, by being so construed, become any the less objectionable. The cases relating to the practice of bankers in charging compound interest have not, therefore, any application to mortgage transactions. (See too Rufford v. Bishop, 5 Russ. at p. 353).

It was, however, with mortgage transactions that Singleton, J., was concerned in the other two authorities upon which the Special Commissioners and Lawrence, J., relied in the present case. These two authorities were Carnarvan (Earl) v. Inland Revenue Commissioners and Marland v. Inland Revenue Commissioners. In the first of them the mortgagor agreed to pay interest on a named day in each year and it was agreed that if such interest were not paid on the due date it should be deemed to be a new loan and should be capitalized and added to the principal sum and should thenceforth carry interest. As each installment of interest fell due the net amount thereof, after deducting income tax was added by the lenders to the principal sum in accordance with the agreement. A question subsequently arose between the borrower and the Crown as to whether he had paid the interest in each year so as to be entitled to deduct it in competing his income for the purposes of sur-tax. Singleton, J., held that the interest had been paid. He said (19 Tax Cas., at p. 465) :

"Under the loan agreement interest was payable. True, the interest was in fact capitalized. That was done as a result of the provision of the agreement as to what should happen if the interest was not paid on the due date. I find it difficult to draw a distinction between such a case and the method in which the account was kept by the bank in Holders Case; and it seems to me that the same reasoning applies as that of Romer, L.J., which I have already cited (100 L.J.K.B., at p. 447; [1931] 2 K.B., at p. 100; 16 Tax Cas., at p. 560) : The company must be deemed to have paid each half year the accruing interest by the means of an advance made for that purpose by the bank to the company. It is true that that was a case as between banker and customer; but I do not see why, under the agreement in the present case, the appellant should not be deemed to have paid the interest by reason of an advance made for that purpose by the insurance company."

It is not material for the present purposes to consider whether or not the decision of the learned Judge can be supported upon other grounds. We are, however, for the reasons already given, unable to agree with him that the decision in Holders case justified his conclusion. The question before him was purely one of the proper construction to be placed upon an express agreement between a mortgagor and his mortgagee. That agreement provided in terms for the addition of interest to the capital sum as a new loan. We do not think that when that provision was carried into effect the mortgagor could properly be regarded as paying the interest out of the new loan.

The facts in Marlands Case were slightly different. The principal sum and interest chargeable annually were secured on a policy of insurance, and the loan agreement provided that compound interest was to be charged on all interest remaining unpaid for more that one month. The borrower was not to be personally liable for the payment of either principal or interest, but the borrower could, if he thought fit, pay the interest within one month after it fell due. He did not on any occasion pay the interest within one month after it fell due, and in each case the net amount was added to the loan by the mortgagees and interest thereafter was charged upon it. The same question arose between the borrower and the Crown as had arise in Lord Carnarvans Case, and was again decided by Singleton, J., in favour of the borrower upon the authority of Holders Case.

In our opinion that decision cannot be supported. In that case there was not even any provision for capitalisation of interest in the strict sense, but merely a provision for charging compound interest. There is not, in our judgment, any justification, either in principle or in authority, for treating the latter provision as one that involves a notional payment of the interest at each yearly or half yearly rest as the case may be.

In these circumstances, it is, in our opinion, impossible to treated the interest in the present case as having been paid by the mortgagor half yearly out of the sums advanced to him for the purpose by the society.

But this by no means disposes of the matter. It is still necessary to examine the transactions between the parties for the purpose of seeing whether the respondents are persons by or through whom any payment of interest has been made within the meaning of rule 21(2).

Turning once more to the rule, it will be seen that it imposes on every such person an obligation to deduct out of the interest a sum representing the tax thereon. It is plain that this does not necessitate the actual setting aside of case to meet the tax. A deduction in account is sufficient. If, instead of paying the full amount of the interest, the debtor pays to his creditor the interest less the tax, he has fulfilled his obligation, even though the payment exhausts his cash in hand or, if paid by cheque, leaves nothing standing to his credit at his bankers. So long as the net interest and no more reaches the hands of the creditors the Crown has no cause for complaint. Nor can the Crown be concerned with the form in which the net interest reaches the hands of the creditor. The creditor may, if he thinks fit, agree to accept in full satisfaction of the net amount a bill or a bond or a chattel provided that the money value of what he gets in exchange does not exceed the net interest due. If this be so, a mortgagor and a mortgagee may validly agree that, in the event of failure by a mortgagor to pay the net interest as it falls due, the mortgagee will from time to time accept in full discharge of the mortgagors liability to pay it, a capital charge for a like amount upon the mortgage security. As and when each charge takes effect the tax will have been deducted within the meaning of the rule, for the capital charge merely takes the place exceed that net amount in money value.

In our judgment the arrangement that was made between the mortgagor and the society in the present case was of that nature. It is true that by the deeds of mortgage and further charge the mortgagor covenanted to pay the full rate interest. But whether such interest was payable out of profits and gains brought into charge or not, the mortgagor could not have been compelled by the mortgagee to more than the net amount. When, therefore, it was provided by clause 5(B) of the mortgage deed that if any interest should not be paid on any half yearly day appointed for its payment, or within thirty days thereafter, the sum due in respect of the half years interest so unpaid should be converted into the become principal money, the sum due must mean the net amount of the interest after deduction of tax. The thing that is to be converted into principal money is the sum that could otherwise have been recovered from the mortgagor; that is the net amount. In this connection it is to be noticed that it is not "the interest" that has to be converted into principal money but "the sum due," a change of language that must have been intentional. In our opinion, in each half year that net interest was added to the capital, the mortgagor deducted the tax as required by rule 21 and the society accepted the capital charge in full satisfaction of the interest after such deduction had been made. This being so, when the respondents paid to the society out of the purchase money the sums that had been so added to the principal moneys secured they were paying a sum that had already suffered tax, and were under on liability to make any further deduction. It is plain that such a sum is not interest within the meaning of the rule.

In these circumstances it is unnecessary to express any opinion upon the question whether, in view of the respondents position in the matter, they could in any case be properly described as persons by or through whom the interest had been paid.

The appeal fails and must be dismissed with costs.

Appeal dismissed.