Associated Portland Cement Manufacturers Ltd v Inland Revenue Commissioners Associated Portland Cement Manufacturers Ltd v Kerr (Inspector of Taxes)

 

Associated Portland Cement Manufacturers Ltd v Inland Revenue Commissioners Associated Portland Cement Manufacturers Ltd v Kerr (Inspector of Taxes)

TAXATION; Income Tax

COURT OF APPEAL

LORD GREENE MR, MACKINNON AND TUCKER LJJ

23, 26 NOVEMBER 1945

Income Tax – Capital or revenue expenditure – Company directors retiring from office – Covenants in restraint of trade – Payments made by company to

retiring directors in consideration of covenants – Payments not deductible from company’s trading profits as revenue expenditure – Capital expenditure –

Income Tax Act, 1918 (c 40), Sched D, Case I.

Revenue – National Defence Contribution – Payments made by company to retiring directors – Payments made in consideration of covenants in restraint of

trade – Whether payments capital or revenue expenditure – Finance Act, 1937 (c 54), Sched IV

S and C, directors of the appellant company, retired from office in 1939. By two similar agreements, dated 3 July and 26 July 1939, respectively, the two

retiring directors covenanted with the appellant company that they would not, after 31 December 1939, without the previous written consent of the company

“carry on or be engaged or concerned in the manufacture of any kind of Portland cement … and other cements for building, constructional or decorative

purposes, lime, whiting or bricks,” within any part of the world. In consideration of those covenants the company covenanted to pay to S the sum of £20,000,

and to C the sum of £10,000. The two sums having been duly paid by the company, the question for the determination of the court was whether, in the

computation of the company’s profits for the purposes of income tax and National Defence Contribution, these two sums ought to be regarded as trading

expenses diminishing the company’s profits for the year in question:—

Held – By buying off two potential competitors the company had improved the value of their goodwill and had, accordingly, brought into existence an

advantage for the enduring benefit of the trade. The payments were, therefore, in the nature of capital expenditure and were not an admissible deduction.

British Insulated & Helsby Cables Ltd v Atherton applied.

Decision of MacNaghten J ([1945] 2 All ER 535) affirmed.

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Notes

The Court of Appeal affirm the court below, holding that sums paid out in order to prevent competition by retiring directors come within the test laid down by

Viscount Cave LC, in British Insulated & Helsby Cables Ltd v Atherton, where he refers to an expenditure made “with a view to bringing into existence an

asset or an advantage for the enduring benefit of a trade.” Lord Greene MR, reviews the question from an accountancy point of view, and points out that in the

majority of cases the question whether an item of expenditure is to be regarded as a revenue or capital payment depends upon the right acquired. On the one

hand an item properly appearing as an asset in the balance sheet may be acquired out of revenue, while, on the other, a capital asset however acquired may be

written down to nothing in the balance sheet. The mere payment out of revenue is, therefore, no sufficient test of whether a capital asset has been acquired.

As to Capital Expenditure, see Halsbury, Hailsham Edn, Vol 17, pp 158–161, paras 325–327; and for Cases, see Digest, Vol 28, pp 47–49, Nos 237–258;

Digest Supp, Income Tax, Nos 244a–252h.

Cases referred to in judgments

British Insulated & Helsby Cables v Atherton [1926] AC 205, 28 Digest 52, 264, 95 LJKB 336, 134 LT 289, affg, SC, sub nom Atherton v British Insulated &

Helsby Cables Ltd [1925] 1 KB 421.

Noble (BW) Ltd v Mitchell (1926), 43 TLR 102, Digest Supp, 11 Tax Cas 372.

Southern v Borax Consolidated Ltd [1940] 4 All ER 412, Digest Supp.

Collins v Adamson (Joseph) & Co Adamson (Joseph) & Co v Collins [1937] 4 All ER 236, [1938] 1 KB 477, Digest Supp, 107 LJKB 121, 21 Tax Cas 400.

Southwell v Savill Brothers Ltd [1901] 2 KB 349, 28 Digest 57, 288, 70 LJKB 815, 85 LT 167, 4 Tax Cas 430.

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Inland Revenue Comrs v Williams Exors, Williams Exors v Inland Revenue Comrs [1942] 2 All ER 266, 167 LT 272.

Appeals

Appeals by the taxpayer, Associated Portland Cement Manufacturers Ltd, from a decision of MacNaghten J, dated 27 July 1945, and reported ([1945] 2 All

ER 535). The facts are fully set out in the judgment of Lord Greene MR.

Cyril King KC and J S Scrimgeour KC for the appellants.

D L Jenkins KC and Reginald P Hills for the respondents.

26 November 1945. The following judgments were delivered.

LORD GREENE MR. In these two appeals the question which arises is whether the appellant company is entitled to deduct for tax purposes, income tax and

National Defence Contribution, two sums of £20,000 and £10,000 which were paid in the circumstances mentioned in the case. In 1939, two directors of the

appellant company, Stevens and Charleton, retired. They had each spent a working lifetime in the service of the appellant company, or of other companies

engaged in the cement trade. Stevens apparently joined the company in 1900 as secretary, and in 1906 he became a managing director. He continued to hold

that office until he retired on 31 December 1939. He was then of the age of 69. Charleton had been associated with the company, or its predecessors, for

some 40 years. He became a director in 1931, and from that date he had charge of an important branch of the company, the coastwise shipping part. In 1939,

at the time of his retirement, he was about 60 years of age.

A person ignorant of the facts might have thought that the retirement of these two directors, which took place in entirely friendly circumstances, was a

prelude to their enjoying during their declining years the leisure which their eminent services had earned them. A person who thought that would have been

mistaken. Stevens, although 69 years of age, was in good health. He was a very hard worker and quite competent to give advice to, or steer the policy of, any

other company. Charleton, although only 60 years of age, does not obtain in the case the same certificate of robust health as Stevens. No specific mention of

his state of health is made. But it is found that the company thought that there would be a very definite danger of his acting in opposition to the company

when his connection with it was severed. Of Stevens, it is said that as he would have been free, had no steps been taken to prevent him, to turn his abilities to

account in the way of lending his name to any enterprise, he might compete with or otherwise act to the disadvantage of the appellant company.

The appellant company, as the case finds, with its associated companies, are the largest manufacturers of cement in Great Britain. The seriousness of the

threat overhanging the prosperity of the company did not escape the vigilant eyes of the other members of the board. The fact that the two retiring directors

might in future engage in competitive activities led the board to think that the appropriate method of protecting the company against such an attack would be

to secure from both of them restrictive covenants which would insure that they should not enter into competition with the company. I use the phrase “enter

into competition” as a convenient phrase to cover the various types of activities in connection with cement with which the contracts deal, and in which the two

retiring directors are prohibited from engaging.

The unimpaired nature of their business abilities appears from the type of activity against which it was thought necessary to protect the company.

Stevens although 69, was in the position when he might apparently become engaged in the manufacture of Portland cement in the British Isles, in Canada, in

India, or in the Republic of Mexico, or in the Union of South Africa, or, indeed, in any other part of the world. Against such activities, and a number of others,

he was precluded by the agreement. The same thing applies to Charleton because the contracts are the same in both cases. Therefore we have this position,

that the company, having on the retirement of these two directors before its eyes the prospect of their competition and desiring to protect itself against that

disadvantage, thought that it was worth £30,000 to impose upon them these restrictions. I should say that the contracts extend apparently during the rest of the

lives of these two directors.

After the execution of the contracts, the two sums of £20,000 and £10,000 􀂭 69􀀉 were paid. It must be taken, for the purposes of this case, that the

benefits secured to the company, although they might well have been more valuable than the sums actually paid, were worth not a shilling, indeed not a penny,

less than £20,000 and £10,000 respectively—not inconsiderable sums. It appears that the board, perhaps through a feeling of modesty, did not expose

themselves to the congratulations of the shareholders upon this important achievement. In the company’s accounts a rather remarkable entry appears. The

accounts laid before the shareholders consisted of a profit and loss account and a balance sheet. In the profit and loss account appears this item on the receipts

side:

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‘By profit on trading (including compensation under a working agreement) after deducting management expenses, bad debts, sundry reserves and

provision for taxation, £879,282.’

The words with which we are concerned are the words “sundry reserves.” That balance of £879,282 is a balance on trading account carried into the profit and

loss account. The trading account was not put before the shareholders. Nobody can complain of that. But when one looks into the trading account, one finds

an item entitled: “Sundry special reserves, £30,000.” That £30,000 was the sum of the two amounts of £20,000 and £10,000 with which we are concerned.

The words “sundry reserves” in the profit and loss account include that item. It was Voltaire (who had a certain dislike of shams) who said of the Holy Roman

Empire that it was neither Holy nor Roman, nor an Empire. He perhaps would have been less severe on this particular description. Although he might have

quarrelled, and properly quarrelled, with the word “sundry” and with the word “reserves,” he might very well have agreed that the expenditure in question was

“special.” Apart from that possibility, I cannot imagine a more inaccurate entry than this. However, we are not directly concerned with that.

I only mention it for one reason. We were invited by counsel for the appellants to pay particular attention to the evidence of the company’s auditors, who

expressed the view that these sums could not be treated as a capital item in the accounts. Although there is no auditors’ certificate attached to the profit and

loss account, or to the trading account, it seems a reasonable inference that this particular entry did not pass the auditors unobserved. In those circumstances, I

may not perhaps be thought peculiar if I feel some reluctance in allowing myself to be guided on the theory or practice of accountancy by this company’s

auditor.

But before I leave the question of accounts, I should say this. On the question whether an item of expenditure is of a capital or a revenue nature, it is no

doubt helpful to consider the circumstances from the accountancy point of view. But one must be careful to define one’s terms. Whether or not an item of

expenditure is to be regarded as of a revenue or capital nature must in many, and, indeed, in the majority of cases, I should have thought, depend upon the

nature of the asset or the right acquired by means of that expenditure. If it is an asset which properly appears as a capital asset in the balance sheet, then that is

an end of the matter. But it must never be forgotten that an asset which may properly, and quite correctly, appear, and only appear, in the balance sheet as an

asset may be acquired out of revenue. There is nothing in the world to force a company or a trader who buys a capital asset to debit the cost of it to capital.

Conservatively managed companies every day pay for capital assets out of revenue if they are fortunate enough to have the revenue available. It is, therefore,

no sufficient test to say that an asset has been paid for out of revenue because the consequence does not, by any means, necessarily follow that it is an asset of

a revenue nature as distinct from a capital nature. Similarly, there is nothing to prevent a company or a trader who has acquired a capital asset from refraining

from placing any value on that asset in his balance sheet. I put to counsel for the appellants an example which I think is worth repeating. If a trader buys up

somebody else’s business and pays £10,000 for the goodwill, that being the price on which the vendor insists, there is nothing in the world to prevent the

purchaser paying the £10,000 out of revenue and debiting it to revenue account, and then writing down the goodwill in his own balance sheet to nothing. The

fact that he has written it down in his own balance sheet does not mean that he has not got an 􀂭 70􀀉 asset. He has; he has the goodwill, but for his own

domestic purposes he chooses not to put a value upon it; just in the same way as many companies, who have patents of very great value indeed, are in the habit

of valuing them at a pound in their balance sheet, or at some other nominal sum. I venture to think, therefore, when one is considering the nature of an asset

acquired by a piece of expenditure, it is by no means conclusive to find that the asset does not have any definite value set upon it in the balance sheet.

When one looks at what happened in the present case, first of all one finds that the company chose to make these payments out of revenue. As I have

said, that is by no means conclusive as to their nature. In their balance sheet they did not put any item representing the value, which is £30,000, and not a

penny less, of this asset. But that again is by no means conclusive, as I have just ventured to point out. They have not thought that a value could definitely by

put upon this particular asset. From the business point of view, that is quite natural. It is not good business to put values on assets of a rather vague and

intangible nature like this. A balance sheet does not commonly contain such things, and it might be depreciatory to the company if it did. The fact that you do

not find a value put upon it is, to my mind, of comparatively little importance in the present case.

What is the true nature of the asset which the company has acquired? It has acquired two choses in action, the benefit of two restrictive covenants against

competition, using that phrase again comprehensively, for which it has paid a total sum of £30,000. The danger against which these covenants protected the

company was serious and imminent. It would be quite wrong to allow oneself to think for a moment that the company was not getting its money’s worth.

When the two directors left the board, they were free to compete, not merely in Great Britain, but in Mexico, and, indeed, in the South Sea Islands. Against

that danger the company has protected itself. What is the true business result of all that? When the two directors left the company, the goodwill of the

company would immediately have become extremely vulnerable. When the company had the monopoly of their services, it was in a very advantageous

position. As soon as they became potential competitors there was ground for thinking that the goodwill of the company would receive a serious shock. The

risk of competition and damaging competition was great. The company succeeded in protecting itself against that risk. In effect the company was buying off

two potential competitors. It seems to me that the effect of buying off potential competitors must of its very nature affect the value of the company’s goodwill.

If all potential competitors could be bought off, the goodwill of the business would obviously be very greatly benefited. If some competitors are bought off, if

they are dangerous potential competitors, the goodwill is affected substantially. The true nature of what they have done seems to me to be this. They have

acquired these rights against the two retiring directors, and, by doing so, they have enhanced the value of an existing asset, to wit, their goodwill. In the

balance sheet the company’s goodwill is included in the global sum of £5,751,885. There is a note indicating that the amount of goodwill “included in the

above figure is not shown in the books and is not otherwise ascertainable.” That is a very good example of what I was referring to a moment ago, a capital

asset on which no value is placed in the balance sheet at all. As the value of the goodwill was regarded as not ascertainable, it was not to be expected that the

directors would treat this £30,000 as an addition to it. Accordingly, it does not appear in the balance sheet. But that cannot affect its nature. The fact that the

directors for good business purposes did not choose to value the goodwill of the company in the balance sheet does not prevent the goodwill from being an

asset.

Before turning to the authorities which counsel for the appellants principally relied upon, I might perhaps quote the well known words in the judgment of

Viscount Cave LC, in British Insulated & Helsby Cables Ltd v Atherton, where he says this ([1926] AC 205, at p 213):

‘But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring

benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an

expenditure as properly attributable not to revenue but to capital.’

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That test which Viscount Cave LC, propounds is one which, though I think not by any means exhaustive, is an extremely useful test, and in many cases will

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give the clue to the right answer.

In my opinion, in the present case the language of Viscount Cave LC is satisfied by the facts. This was an expenditure made once and for all with a view

to bringing into existence “an advantage for the enduring benefit of a trade.” There was nothing temporary about this advantage. It was to last during the lives

of the two directors in question. That that advantage was a solid one, I have already endeavoured to point out. That it was “for the benefit of the trade” in a

very true sense is again quite clear because, when analysed, its effect unquestionably was to add to the value of the goodwill. There was all the difference in

the world, as it seems to me, between this case and the case of Noble v Mitchell, on which counsel for the appellants principally relied. The payment made in

that case was made to procure the retirement of a director who was regarded by the board as a person not desirable to retain on the board. It might have done

the company great harm if it had become necessary to dismiss him from the board. But there seems to me to be all the difference in the world between getting

rid of an unsatisfactory servant—and that was the principle on which the case was decided—and buying off a potential outside competitor. In the one case

you are getting rid of a servant, and the sum you pay for that is no more of a capital nature, nor is the benefit any more permanent, than is the wage that you

pay the servant for his services. But when you are buying off an outside competitor, the position is entirely different. Therefore I do not get any assistance

from that case at all.

Southern v Borax Consolidated Ltd was a case where the tax-paying company had spent money in defending its title to certain American land which it

has acquired. The money that you spend in defending your title to a capital asset, which is assailed unjustly, is obviously a revenue expenditure. There again

there is all the difference in the world between defending your assets against the claim of somebody who has no claim against them and acquiring a new asset,

or adding to an existing asset. If you acquire the benefit of a covenant which improves the value of your goodwill, in my opinion you have acquired a capital

asset, even though the goodwill has no value set upon it in the balance sheet. Lawrence J in the Borax case said this ([1940] 4 All ER 412, at p 418):

‘… if it could be said here that this expenditure had in any way altered the original character of the capital asset which was acquired by the

respondent company, I should have taken the view that the payment was in respect of capital, but, as, in my opinion, the capital asset of the respondent

company remained absolutely unaltered, that payment is properly attributable to revenue.’

That brings out the distinction with the utmost clarity.

There is one last case of Collins v Adamson (Joseph) & Co. In that case a trade association, of which the company was a member, had bought the

business assets of another member of the association with a view to prevent it from disposing of its business to an outside firm which was not a member of the

association. The association, when it acquired the business in question, closed it down, and got rid of the assets. The share in cash which the company

obtained was the subject-matter of the question at issue, the question being whether it was a profit which ought to be brought in for tax purposes. It is to be

observed that in that case the company acquired no business asset which could figure in its balance sheet. If the company be regarded as having acquired

through the association, an aliquot part of the assets of the company that was being bought out, the position was that before anything could be put in anybody’s

balance sheet the business acquired was closed down and the assets scattered. Therefore, the company never put into its balance sheet an item representing the

benefit it had acquired. It could, I suppose, have written up its goodwill by an appropriate amount, but no board in their senses would dream of doing that, and

no auditor in his senses would approve of such a course. It would not be business. It would be strictly correct, but it would not be good practice. In his

judgment in that case, Lawrence J, said this ([1937] 4 All ER 236, at pp 240, 241), referring to a case of Southwell v Savill Brothers Ltd:

‘From this case, I think it may be deduced that one cannot test the question as to whether the payment is properly a capital or a revenue payment by

seeing whether 􀂭 72􀀉 it can be shown to be productive. Nor do I think that the argument of Mr. King, that what was produced by the expenditure in

these cases was impalpable or intangible or incalculable, is a sound argument for holding that it must be treated as being of a revenue nature. In fact, in

both these cases, the payments which were made had, as a result, the removal or the prevention of a trade competitor, who would not have been subject

to the rules of the Association. In my opinion, those payments created for the members of that Association advantages of an enduring nature, and of

such an enduring nature, I think, as properly to be treated as capital, and not to be treated as revenue … The fact that the value of that acquisition is

doubtful is, of course, applicable to almost every trade acquisition, and was equally applicable to the value of the fund created in Atherton’s case; but in

both cases the trader had himself put a value upon the advantage which he was acquiring. In Atherton’s case the sum transferred to this pension fund

was the sum which the directors of the company thought it wise to set aside, and here the sum paid by the Association was the sum which they thought it

worth while to pay to remove from the arena a possible competitor, who was supposed to be going to purchase the business of Hewitt and Kellett, Ltd.’

Those observations, in relation to the particular subject-matter with which the judge was dealing, in my opinion, were entirely correct, if I may respectfully say

so, and are peculiarly applicable to the present case. They bring out what I have endeavoured in less felicitous language to bring out, namely, the caution with

which one must regard entries in accounts in deciding these questions.

Counsel for the appellants [Mr Scrimgeour KC] then put forward this argument. He said that these contracts, when properly regarded, were not made to

create a new asset, but to mitigate the loss to the business which the business would suffer from the loss of these two directors’ services, and he referred to

Inland Revenue Comrs v Williams’s Executors. In my opinion, that case has no application to the present case at all. The circumstances were entirely

different. The question was different, and the considerations on which the case was decided have no bearing on what is in question here. The real fact of the

matter was that the loss which occurred from the loss of the services of the two directors could not be mitigated. Their services were lost to the company. By

no means could the company take them back except by re-engaging them. Their departure from the company brought into existence something totally

different, namely, the risk of a positive detriment to the company due to competition. It was against that, and that alone, that these contracts were directed.

As I have said, these benefits acquired by the company were solid; they were permanent; and they were world-wide. They protected the company against

certain risks, and the value to be set on that protection was shown by the company itself in deciding to pay these amounts. No doubt it will be a

disappointment to the company that they cannot crown their success in acquiring these solid advantages by passing on to the general taxpayer the privilege of

paying for a large part of the expense so incurred. The appeal must be dismissed with costs.

MACKINNON LJ. I agree, and I have very little to add, but I am tempted to add a few remarks with regard to the rather singular transaction which gave rise

to these proceedings. Stevens, a managing director, was subject to an agreement, which is annexed to the case, of July, 1935, and by the terms of that

agreement he undertakes during his term of office to devote the whole of his time, attention and abilities to the business of the company. This arrangement to

pay him £20,000 was arrived at at a meeting on 13 July 1939, when it is stated that he expressed a desire to retire after 31 December 1939. In accordance with

the resolution then carried, he and the company entered into a deed dated 26 July 1939. By that deed the company undertakes to pay Stevens £20,000 in

consideration of his not competing with them in the future. It further provides expressly “that if Stevens should die before the said 31 December 1939“—that

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is the date of the prospective retirement—“the company will pay the said sum of £20,000 to his legal personal representatives.” In the case of Charleton, there

was apparently no service agreement between him and the company, but it is found in the case that there was nothing to prevent him from resigning, but the

company felt that while he was in office he would not act in opposition to it. On the other hand, when he was no longer in office, the company felt that there

would be a definite danger of his so acting.

In Charleton’s case the meeting at which the payment of £10,000 to him was decided upon was on 26 January 1939, at which he stated that he desired to

retire 􀂭 73􀀉 on 30 September. It was thereupon agreed that a similar arrangement should be entered into with him, substituting £10,000 for the £20,000 in

Stevens’ case, and that was done by a deed dated 3 July 1939. That also provides that if Charleton should die before 30 September the company will pay

£10,000 to his personal representatives. If Stevens and Charleton had both died in Aug 1939, the directors would have had to pay £30,000 to their respective

executors, and I am quite satisfied that it would have been giving away part of the money of the company because there was clearly no consideration whatever

for any such undertaking. As they did survive, it may be said that there was some consideration for the £30,000 paid to them, but I am quite clear that it was a

capital payment and not an item of the company’s expenses to be charged against revenue.

Among these varied cases, the only one in which anything approaching to principle can be discovered is the opinion of Viscount Cave LC, in British

Insulated and Helsby Cables Ltd v Atherton, where, as to this question of revenue or capital, he said ([1926] AC 205, at p 213):

‘This appears to me to be a question of fact which is proper to be decided by the Commissioners upon the evidence brought before them in each case

… ’

In this case the Commissioners have found that it was of a capital nature, and not a proper charge to revenue, and there was clearly ample evidence on which

they could so find. The other material passage is a little later in the opinion of Viscount Cave LC where he says ([1926] AC 205, at p 213):

‘But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring

benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an

expenditure as properly attributable not to revenue but to capital.’

Applying that principle in this case, there is an additional reason to my mind for thinking that the Commissioners came to the correct conclusion in the facts

which they have stated in the case, and that in consequence the judgment of Macnaghten J was entirely right.

I agree that the appeal should be dismissed with costs.

TUCKER LJ. I agree, and I have nothing to add.

Appeal dismissed with costs.

Solicitors: Linklaters & Paines (for the appellants); Solicitor of Inland Revenue (for the respondents).

F Guttman Esq Barrister.

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