Cross (Inspector Of Taxes) v. London Provincial Trust, Ltd.

GREENE, M.R. - The question involved can be stated in a few words. It is this : Were the funding bonds when received "income arising from securities outside the United Kingdom" ? The Crown says that they were moneys worth received in satisfaction of interest payable under the original bonds. The respondents say that they have received no income from those bonds, in that all that they have received is a substituted promise to pay the interest at a future date with interest thereon in the meantime.

It is not open to question that income can be in the form of moneys worth. Nor it is pen to question that if the holder of a security, the contractual income from which is money, receives from the person liable to pay that money something of moneys worth (for example, goods) instead of money, such goods are income arising from the security; Scottish and Canadian General Investment Co. v. Easson, where debentures of a new company were received in place of interest due on bonds issued by an old company. On the other hand, where there is a mere substitution of a promise to pay at a later date for the obligation to make an interest payment presently due, the owner of the security cannot be said to have received income from it. In such a case in truth that is exactly what has not happened, since the payment has been postponed instead of being made on its due date. Nor do I see how it can make any difference if upon the true reading of the transaction the original obligation is extinguished and the promise to pay at a later date is accepted in its place. If the holder of a mortgage agrees to accept a post-dated cheque in lieu of interest which has accrued due it would surely be a misuse if language to say that he had received income from the mortgage, and that notwithstanding the fact (which I will assume) that the post-dated cheque was a thing of moneys worth. A question of this nature arose under the Indian Income Tax Act, 1922, in Income Tax Commissioner v. Maharajadhiraja of Darbhanga. There, under an arrangement between debtor and creditor, the creditor took from the debtor, in satisfaction of principal and interest due, certain assets and also certain promissory notes of the debtor himself, a sufficient number of which were held to be property referable to the interest due. It was held by the Privy Council that the receipt of these notes could not be treated as the receipt of income. Lord Macmillan in delivering the judgment of the Judicial Committee said (L.R. 60 Ind. App., at p. 161) : These is, of course, no doubt that a liability to pay interest, like a liability to make any other payment, may be satisfied by a transference of assets other than cash and that a receipt in kind may be taxable income. But for this to be so, it is essential that what is received in kind should be the equivalent of cash or, in other words, should be moneys worth (Californian Copper Syndicate v. Harris; Scottish and Canadian General Investment Co. v. Easson), both cited by Das, J., below. Now here, the first six items, amounting to 20,74,973 rupees, may perhaps reasonably enough be regarded as the equivalent of cash, but the seventh item of 17,34,596 rupees, consisting of the debtors own promissory notes, was clearly not the equivalent of cash. A debtor who gives his creditor a promissory note for the sum he owes can in no sense be said to pay his creditor; he merely gives him a document or voucher of debt possessing certain legal attributes. So far then as this item of 17,34,596 rupees is concerned, the assessee did not receive payment of any taxable income from his debtor, or indeed any payment at all.

On the same day the judgment of the Judicial Committee was delivered by Lord Macmillan in another case, that of Raghunandan Prasad Singh (Raja) v. Bihar and Orissa Income Tax Commissioner. There the assessees, who were holders of a mortgage on which interest was in arrear, accepted in discharge of that mortgage and all sums due thereunder a new mortgage for a principal sum part of which represented the arrears of interest due under the old mortgage. The grantors of the new mortgage were not identical with the grantors of the old mortgage and the property mortgaged was greater in extent. The assessees claimed that the acceptance of the new mortgage and the extinction of the old mortgage operated as payment of the arrears of interest, with the result that the amount of those arrears ought to have been brought into charge in the year in which the new mortgage was accepted. The judgment, after examining the decisions in Californian Copper Syndicate v. Harris, Royal Insurance Co. v. Stephen, and Westminister Bank v. Osler, summed up the result in the following words (L.R. 60 Ind. App., at p. 138); "From these cases it is plain that the essence of the matter is that there must be an actually realised or realisable profit or loss." It then proceeded to point out that in receiving the new mortgage the assessees "did not thereby receive payment or the equivalent of payment of the principal and interest of the original mortgage", and that notwithstanding that the mortgagors and the property mortgaged were not identical, the substitution effected cannot in any real sense be described as the equivalent of a realisation of the original mortgage, principal and interest. What happened was that the assessees received a new and substituted security for an existing debt. To give security for a debt is not a pay a debt. If the assessees had received payment in kind of the amount outstanding on the original mortgage, in the shape, say, of realisable shares or bonds, the case would have been different, but they merely received further and better security for their debt. It is in their Lordships view quite immaterial that the assessees discharged the original mortgage and all liability under it, for that was merely an incident in the transaction whereby the new security was substituted for the old."

It is clear that the "realisable shares or bonds" referred to in this passage are shares or bonds issued by some company, since the assessees were individuals and the expression therefore could not refer to some such security issued by them. It is to "realisable" things of this character that the phrase "realisable profit of loss" in the passage first cited from the judgment clearly refers.

Now, it is to be observed, that this case is a much stronger case than that of the post-dated cheque or that of the notes of hand dealt with in the earlier case. The essential fact was that the new mortgage was given to secure the existing debt and could not be regarded as payment of that debt, as would have been the case if something "realisable" or "the equivalent of cash" had been given to the creditor.

I have quoted the language of this latter case because much of the reasoning which it contains is applicable to the present case. Neither decision is, of course, an authority binding on this Court and I wish respectfully to reserve for consideration whether, if a case similar to the second of the two cases were to arise under the English Income Tax Acts, the circumstance that the mortgagors under the substituted mortgage were not the same as those under the original mortgage might not be of importance. But, subject to this reservation, I respectfully agree with the reasoning on which these two decisions are based. A security produces the Income appropriate to it. The income appropriate to a money bond is money. The parties may agree to substitute something different as income of the security and the thing so substituted (for example, goods) thereupon becomes the appropriate income of the security. But where the debtor defaults and the appropriate income being money is not changed into something else, but remains money which the debtor promises to pay at a later date, it does not appear to me to be possible to say that the security has produced any income, since the income which the security was intended to provide has not been provided. This circumstance is not affected by the facts that (as in the present case) a new undertaking to pay is given; that such new undertaking is in a form which can be conveniently dealt with on the market; or that such new undertaking may contain provisions intended to give better security for the money due. The inescapable fact remains that the interest due on the original bonds held by the respondents has not been paid.

All the arguments put forward on behalf of the Crown really come down to the same thing, namely, that because the funding was of moneys worth, it therefore follows that the respondents, in receiving it, received an income profit. But this proposition will not bear examination. It involves the assumption that whenever the holder of a security receives from that security moneys worth he receives income, and this is not the case. It is one thing to say that income is none the less income because it is received in the shape of moneys worth instead of money -this proposition is true; it is a totally different thing to say that the receipt of moneys worth is necessarily a receipt of income - this proposition is not true. When a bond is issued with coupons attached the coupons are moneys worth - they can be sold before maturity under discount, yet it could not be suggested that in receiving the coupons the holder of the bonds had received income. Again, when the coupons originally attached to the bond have all been paid and the holder of the bond sends in the talon and receives a new set of coupons he receives moneys worth, for the coupons are of value, but he does not for the reason receive income. Again, in the case which I have given of the post-dated cheque, the cheque is moneys worth but it is most certainly not income. In all these cases the appropriate income of the security is money and remains money - there is no substitution of some other form of income for money, and unless and until the security had produced money, or something substituted for money, it has not produced income.

In the present case the form of the funding bond and the fact that it is marketable security tend to conceal the fundamental petition principle which underlies the Crowns argument. There were no doubt sound commercial reasons for issuing a document of this kind. But when its true nature is considered it is nothing but a promise to pay at a future date the interest in respect of which default has been made. The fact that the promise to pay this interest takes the form of a marketable instrument appears to me to be irrelevant. The coupon itself presumably had some value before the default. If the funding bond has more value than the coupon had that merely means that the debtors promise to pay embodied in it is of more value than his original promise to pay; it does no mean that he had paid, for he has not. The tree has produced no fruit, to use a well-worn simile; the owner of the tree has refused to allow it to be picked and has merely given a voucher entitling the holder to pick it at a future date.

Of the authorities cited in the course of the argument, there is only one to which I think it necessary to refer, namely, the case of Inland Revenue Commissioner v. Lawrence, Graham & Co. In that case under the provisions of a mortgage deed on default of payment of any half-years interest, "the sum due in respect of the half-years interest so unpaid" (which in point of construction was held to mean the net sum after deduction of tax) was to be converted into principal money and added to the amount of the loan. Default took place, the provisions of the mortgage deed took effect, and on a subsequent sale by the mortgagees their solicitors who received the purchase money paid over to the mortgagees (together with other moneys) a sum of Pounds 2,378 and 19s., representing the net interest capitalised, and paid the balance to second mortgages. The Crown claimed that on paying this sum of Pounds 2,378 and 19s. to the first mortgagees the solicitors were paying interest within the meaning of rule 21 not payable out of profits or gains brought into charge that on such payment they were bound under the rule to deduct tax, and that they were assessable in a sum equal to the gross amount of the interest.

The real question which arose was whether, having regard to the terms of the mortgage deed when properly construed, the mortgagor had deducted tax on each occasion when the interest was capitalised, and it was held that he had done so. By the terms of the contract itself, providing as it did for capitalisation of the net amount, the capitalisation was treated by the parties as a payment in account as between mortgagor and mortgagee - the fact that the sum to be capitalised was a net sum inevitably produced this result. This case, which turned upon the effect as between the parties of a particular provision in the original contract, is not in my opinion of any assistance in the decision of the present question. In the present case a defaulting debtor, instead of paying the interest due, has repudiated its obligations. This appears from the opening words of the circular referred to at the beginning of this judgment. It offered to its creditors a promise of deferred payment the acceptance of which (and there was no alternative) cannot in my opinion upon the facts be treated as though it were payment.

In the result I am in agreement with the decision of the learned Judge and this appeal must be dismissed with costs.

I am authorised by Lord Romer to say that he has read the judgment which I have just delivered and agrees with it, and has nothing to add to it.

Mackinnon, L.J., stated the facts and continued : There was, therefore, a foreign security on which interest was payable, which interest, if paid, would constitute income from a foreign security The debtor having refused to pay the interest, issued a document promising to pay in twenty years time. The promise in this document being assignable, it was salable and was sold. The question is whether the money realised from the sale of this promise to pay in future the interest on the security can properly be said to be "income from the security".

I agree with Finlay, J., in thinking that the answer to this question must be in the negative.

It is important to realise clearly the essential nature of this transaction -, and that is apt to be obscured by the fact that what the debtor handed over in lieu of payment was a document possessing the character of a marketable security. The essential nature of the transaction was that the debtor, avowing his inability to pay what had fallen due, gave instead his written promise to pay at a future date. He might just as well have given his own post-dated cheque. Or, still more simply, he might have written on each of the gold bond coupons a promise to pay it in twenty years, with interest annually until payment.

It is quite true that income may arise by the receipt of moneys worth as well as by the receipt of money. And it is equally true that a debtor may pay his debt by giving the promise of a third party to pay; indeed the best form of payment in the world, Bank of England notes, if subjected to the unusual treatment of being read, will be found to be promises by a third party to pay. But I am satisfied that there can never be payment of his debt by a debtor by giving his own promise to pay at a future date. And I am equally satisfied that, though income arises to a creditor from doubters paying his debt, income does not arise by the debtors promising that the will pay his debt later on. This appears to be precisely the reasoning of the Privy Council in Income-tax Commissioner v. Maharajadhiraj of Darbhanga. Lord Macmillan there said (L.R. 60 Ind. App., at p. 161) : "... the seventh item... consisting of the debtors own promissory notes, was clearly not the equivalent of cash. A debtor who gives his creditor a promissory not for the sum he owns can in no sense be said to pay his creditor; he merely gives him a document... possessing certain legal attributes. So far then as this item... is concerned the assessee did not receive payment of any taxable income from his debtor or indeed any payment at all." To which I would add, so as to include the further incident which occurs in this case, that if the debtor cannot be said to have paid his creditor by giving him his promissory note, equally he cannot be said to have paid his debt when the creditor realises some money by assigning the promissory note to a third party. And as the creditor does not receive payment from his debtor when he receives his promissory note, nor does "income arise" from that receipt, so equally he does not receive payment, or acquire income, when he sells the promissory note for what it will fetch.

I agree, therefore, that this appeal should be dismissed.

Appeal dismissed.