Scottish Court of Session Decisions

The Scottish Investment Trust Company, Limited, was established in 1887 with the object, as stated in the prospectus, of applying the principle of co-operation to the investment of money, so that investors may, by uniting their means, spread their investments over a wide field. The objects of the company, as stated in the 3rd article of the memorandum of association were, inter alia—( a) To raise money by share capital, on such terms and conditions as may be thought desirable, and invest the amount thereof in any of the investments following.…( b) To borrow or raise money by the issue or sale of any bonds, mortgages, debentures, or debenture stock of the company, … and to invest any money so raised … ( c) To acquire any such investments as aforesaid by original subscription, tender, or otherwise … and to vary the investments of the company, and generally to sell, exchange, or otherwise dispose of, deal with, or turn to account any of the assets of the company. … ( k) To do all such other things as are incidental or conducive to the attainment of the above objects.

In the 5th annual report to the shareholders for the year ending 1st November 1892, it was stated that

“The book value of the investments has been written down by the sum of £42,138 17 3

“Thus: As resolved at last annual general meeting,	£40,000	0	0
Net profits on sales of securities during the year,	2,138	17	3
	42,137	17	3”

The Commissioners for the General Purposes of the Income-Tax Acts for the county of Edinburgh made an assessment on the company under Schedule D of said Acts on the above sum of £2138, 17s. 3d., but at the request of the company, who objected to the assessment, stated a case for the Court of Exchequer, in which, after setting forth the establishment and objects of the company, they went on to say—“On behalf of the company it was contended (1) that the profits on sales having been properly charged to capital account, and not having entered the income account of the company, are not liable to income-tax. 2) That the business of this company is to invest the capital of the company in different bonds and stocks with the object of averaging risks, and to divide the dividends and interest received. The income of the company is derived from the dividends and interests of the company's investments. The company does not consider it part of its business to buy and sell stocks and shares with the view of making a profit, and has never divided such profits among its shareholders. (3) In the year in which the tax is charged, the capital account of the company has had greater losses than profits, and the permanent loss on the capital account during the year has been considerable. (4) The directors of a limited company are entitled where there has in their opinion been a permanent depreciation in value of the capital of the company to treat the increment of value on some of their capital as a set-off against the depreciation in value of other capital assets, so as to keep the capital value of their whole assets up to its proper standard, by retaining such profits in the capital account and not carrying them to revenue account. (5) In the case of the Northern Assurance Company v. Russell, cited for the Inland Revenue, the facts were entirely different from the present case. In that case the profits on sales were credited to revenue and divided as dividend. In the present case it has been necessary to retain such profits in the capital account to meet permanent depreciation of investments.

The Surveyor of Taxes, Mr R. S. Forbes, on the other hand, contended that (as appears from the annual reports) the company made a practice of realising securities, and such sales were obviously part of its business, and the balance of gain made fell to be reckoned among its profit. He referred to the decision of the Judges in the case of the Northern Assurance Company v. Russell, February 8, 1889 (No. 122 of Tax Cases), that ‘Where the gain is made by the company (within the year of assessment, or the three years prescribed by the Income-Tax Act, Schedule D), by realising an investment at a larger price than was paid for it, the difference is to be reckoned among the profits and gains of the company.’ He did not dispute that loss on sales would have been a deduction from profit, but he pointed out that the sum now in question was ‘net profits.’ He maintained that, it having been admitted that as a matter of fact the profits were made, the mere mode of informing the shareholders of it—whether by putting the amount into the revenue account (as was done for year to 1st November 1891), or by mentioning it only in the report, was immaterial to assessment; further, that the application of realised profits to compensate for writing down ‘book value’ of investments of the capital of the company did not exempt such profits from assessment under the Income-Tax Acts.

We, the Commissioners, being of opinion (1) that the net profits on sales of securities during the year fell to be reckoned among the profits and gains of the company, irrespective of the manner of book-keeping, and (2) that writing such profits against reduction of ‘book value’ of securities held by the company did not afford a ground of relief, refused the appeal.

Whereupon the appellant expressed dissatisfaction with our decision as being erroneous in point of law, and craved that a case might be stated for the opinion of the Court of Exchequer, according to

Page: 221↓

Statute 43 and 44 Vict. cap. 19, and which we have stated and signed accordingly.”

The questions for the opinion of the Court are—“(1) Whether the net gain made by the company during the year, by realising investments at larger prices than were paid for them, falls to be reckoned among the profits and gains of the company for assessment under the Income-Tax Acts? (2) Whether the fact that such profits and gains have been written against depreciation in book value of investments held by the company, as part of its capital, is a ground for relief from such assessment?”

Argued for the company—The Commissioners of Inland Revenue had gone beyond their sphere, and had encroached upon capital. The sum in question was capital not income. The cases relied on by the Inland Revenue only applied if it was found to be income. In the case of the Northern Assurance the directors had put themselves out of Court by treating the sum in question as income. In the Edinburgh Cemetery Company's case two considerations were present, neither of which was here—the profits in question were the ordinary profits of the company, and they had been devoted to income purposes. The sum here was not available for income purposes such as payment of dividend. The power of varying investments was auxiliary to the objects of the company, but was not itself an object. Speculating on the rise and fall of stocks was no part of the company's business. The inducement to join the company was that there was a large capital spread over various investments. They were entitled to put a profit accruing from a realisation of part of their capital against depreciation in the rest of their capital, and that was all that had been done here.

Argued for the Inland Revenue—The company's own words were fatal to their case. The sum in question was “net profits,” and was subject to assessment for income-tax. The destination or application of that sum was immaterial. It was only made capital artificially by the company to set off against a merely presumed depreciation. By the memorandum of association varying investments was one of the ways, whether a principal way or not, by which this company proposed to make profits. The case was ruled by the Northern Assurance Company, &c. v. Inland Revenue, February 8, 1889, 16 R. 461 (see p. 475); Coltness Iron Company v. Inland Revenue, January 7, 1881, 8 R. 351 (Lord President Inglis' observations), and April 7, 1881, 8 R. (H.L.) 67; Edinburgh Southern Cemetery Company v. Surveyor of Taxes, November 14, 1889, 17 R. 154; Gillatt & Watts v. Colquhoun, December 1884, 2 Tax Cases 76 (see p. 83); Forder v. Handyside, 1822, 1 Exch. Div. 233.

At advising—