Casey (Inspector of Taxes) v AB Ltd

• Judge: Teevan J.
• Judgment Date: 31 July 1964
• Court: High Court

Income tax - Schedule D - legal costs in defending action in High Court for balance alleged to be due to a building contractor in respect of the construction of cinema - whether the costs were incurred in earning the profits assessed, and whether they were capital or revenue expenditure - ITA 1918 Sch D Case I.

The company was assessed to income tax under Sch D Case I for the years 1956/57 and 1957/58 on the basis that the aforementioned amounts of £678 and £225 were capital expenditure, and hence, not admissible deductions in computing the profits for assessment for the years in question. On appeal the assessments were confirmed by the Special Commissioners. The Circuit Court Judge, however, on a re-hearing of the appeals, decided in favour of the company. The inspector expressed dissatisfaction with the decision and demanded a case for the opinion of the High Court.

Held, in the High Court, reversing the decision of the Circuit Court Judge, that the law costs were not disbursements made in earning the profits for the years in question, nor were they trading losses, but they were solely referable to the capital structure of the company and, accordingly, ought not to be taken into account in arriving at the assessable income.

Legislation

ITA 1918 Sch D Case I, ITA 1967 s 61.

Cases referred to in judgment

Atherton v British Insulated and Helsby Cables Ltd 10 TC 155.

Davis v M 2 ITC 320, [1947] IR 145.

Golder v Great Boulder Proprietary Gold Mines Ltd 33 TC 75, [1952] 1 AER 360.

Hodgins v Plunder and Pollack 6 TC 399, [1957] IR 58.

Kealy v O’Mara 2 ITC 265, [1942] IR 616.

McGarry v Limerick Gas Committee 1 ITC 405, [1932] IR 125.

Mitchell v Noble 11 TC 732, [1927] 1 KB 719.

Moore v Hare 6 TC 572, [1915] CS 91.

Morgan v Tate and Lyle 35 TC 367, [1955] AC 21.

Quinn v Leathen [1901] AC 495.

Small v Easson 12 TC 351, [1920] SC 758.

Southern v Borax Consolidated Ltd 23 TC 597 [1940] 4 AER 412, [1941] 1 KB 111.

Union Cold Storage Co v Jones 8 TC 725, 129 LTR 512.

Usher’s Wiltshire Brewery Ltd v Bruce 6 TC 399, [1915] AC 433.

Cases also cited

Income Tax Commissioners of Bihar and Orissa Singh [1942] 1 AER 362.

Case stated

1.This matter came before me on 1 March 1958, and upon adjournment thereof, on 20 March 1958, and upon further adjournment thereof, on 9 May 1958, by way of rehearing, pursuant to ITA 1918 s 196, of appeals against the assessments to income tax made upon AB Ltd (hereinafter called “the company”) for the years ended 5 April 1957 and 1958, under ITA 1918 Sch D Case I in the following amounts:

£
1956/57 profits of cinema	3,500
1957/58 profits of cinema	4,438
Less wear and tear	322

2. There were two separate and distinct questions before me for decision:

• (a) Whether certain expenditure incurred on the cinema balcony was allowable as a deduction in computing the profits for assessment to income tax. My decision on that point has been accepted by both sides and this statement will not, therefore, make any further mention of it.
• (b) Whether the company should be allowed as a deduction in computing its profits for assessment the legal and other costs incurred in defending an action at law taken by C (hereinafter called “the contractor”), who built the company’s business premises, against D for a sum alleged to be due under a building contract entered into between them on the 4 January 1947. D was the person acting for the promoters of the company which was registered at a later date.

3. The following facts were proved or admitted in the course of the hearing before me:

• (a) The building contract dated 4 January 1947, related to the rebuilding and extension of the premises now known as the .... Cinema, which was admittedly work of a capital nature in so far as the company promoters were concerned. The building was completed and the cinema opened for business on 17 November 1947. The company was registered on 3 January 1948, and on the same day took over all the assets and liabilities of the business.
• (b) The account with the contractor had not been finally settled and the company assumed all liabilities and responsibilities arising out of or connected with the building contract. When agreement was not reached on the amount still owed him, the contractor, who had originally claimed £1,750, issued a writ in the High Court on 14 October 1949, for £1,275 14s. 2d. as the amount due, as alleged, under the contract dated 4 January 1947. D was named as defendant. Copies of (i) the originating summons dated 14 October 1949, (ii) the plaintiff’s statement of claim dated 21 July 1951, and (iii) the statement of defence and defendant’s counterclaim dated 28 November 1951, were produced, these are annexed to and form part of this case. [Not included in present print]
• (c) The decision of the High Court awarded the contractor a sum of £650 and his costs. The defence of the action was borne entirely by the company and the total bill for costs (including the plaintiff’s) came to £903, which was charged against revenue in the company’s accounts as follows:

£
In the year ended 31 December 1955	678
In the year ended 31 December 1956	225

• The accounts for those years form the basis for determining the profits for assessment to income tax for the years 1956/57 and 1957/58 respectively. The payment of £650 awarded to the contractor was treated as a charge against capital.

4. On behalf of the company it was contended:

• (a) that the outlay of £903 was an admissible deduction in computing the company’s profits for assessment to income tax as it was incurred, in the ordinary course of trade, to preserve the capital of the company from heavy drain,
• (b) that the company was obliged to fight the action in defence of its property and rights against a claim which it considered unreasonable and extravagant,
• (c) that the company’s contention was supported by the decisions in the reported cases of:
• (d) that the allowance of this expenditure was not prohibited by any part of rule 3 of the rules applicable to ITA 1918 Sch D Cases I and II.

5. It was contended by the inspector of taxes:

• (a) that the expenditure was of a capital nature and could not properly be deducted by virtue of the primary rule applicable to ITA 1918 Sch D Case I in computing the profits for assessment to tax, that it was of such a nature that its deduction was prohibited by paras (a), (e), (f) and (g) of rule 3 of the rules applicable to Sch D Cases I and II,
• (b) that the outlay was not incurred either in the course of trade or in earning the profits and was, in fact, directly connected with and inseparable from the acquisition of the company’s main asset. He pointed to the nature of the building contract and argued that the High Court action was the result of the failure to settle the final cost of the building,
• (c) that the case of Southern v Borax Consolidated Ltd 23 TC 597 was concerned with the defence of existing rights against a third party (ie one which was not concerned in the acquisition of the assets in dispute), that the dispute in this case involved the creation of the assets and not an attack on a previously acquired title to them,
• (d) that in the cases of Income Tax Commissioner of Bihar and Orissa v Singh and Golder v Great Boulder Proprietary Gold Mines Ltd 33 TC 75 the question was whether the law costs were incurred by the appellant in course of trade and no question of capital as distinct from revenue expenditure was involved. In this case the problem was whether the expenditure was of a capital or revenue nature.

6. Having heard the arguments of both sides and having read the decided cases referred to, I decided that the company should be allowed the legal expenses claimed. In indicated that I was guided by the decision in Southern v Borax Consolidated Ltd 23 TC 597 in applying the test whether any new capital asset had been created by the expenditure. I referred in particular to the words of Lawrence J at page 602:

On the other question as to whether this is a payment properly attributable to capital or to revenue, in my opinion the principle which is to be deduced from the cases is that where a sum of money is laid out for the acquisition or the improvement of a fixed capital asset it is attributable to capital, but that if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue, being in substance a matter of maintenance, the maintenance of the capital structure or the capital assets of the company,

and, again, at page 605:

It appears to me that the legal expenses which were incurred by the respondent company did not create any new asset at all but were expenses which were incurred in the ordinary course of maintaining the assets of the company, and the fact that it was maintaining the title and not the value of the company’s business does not, in my opinion, make it any different.

Accordingly, I fixed the assessments as follows:

£
1956/57: profits of cinema	2,259
Less wear and tear	341
1957/58: profits of cinema	3,781
Less wear and tear	322

7. Immediately upon determination of the appeals the inspector of taxes expressed to me his dissatisfaction therewith as being erroneous in point of law and, in due course, required me to state a case for the opinion of the High Court pursuant to the provisions of the ITA 1918 s 149, which case I have stated and do sign accordingly.

8. The question of law for the opinion of the High Court is whether I was correct in holding that the costs and expenses incurred by the company in the said action taken by the contractor on foot of the building contract, dated 4 January 1947, were an allowable deduction in computing the company’s profits for assessment to income tax.

High Court - 31 July 1964

Teevan J. The controversy in this case arises on deductions claimed by the taxpayer, AB Ltd in computing their assessable income for income tax for the two years 1956/57 and 1957/58. The company has been assessed on the profits and gains from their...