Willingale and International Commercial Bank LTD

[1978] AC 834

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(Judgment by: Lord Fraser of Tullybelton)

Willingale (Inspector of Taxes)
and International Commercial Bank LTD

Court:

Judges: Lord Diplock
Lord Salmon

Lord Fraser of TullybeltonLord Russell of Killowen
Lord Keith of Kinkel

Subject References:
Revenue
Corporation tax
Computation of profits
Anticipated profits from bills and promissory notes discounted or purchased by bank
Whether tax payable on fractional part of anticipated profits from bills

Legislative References:
Income and Corporation Taxes Act 1970 - Section 108

Case References:
BSC Footwear Ltd v Ridgway - [1972] AC 544; [1971] 2 WLR 1313; [1971] 2 All ER 534
Duple Motor Bodies Ltd v Inland Revenue Commissioners - [1961] 1 WLR 739; [1961] 2 All ER 167
Gardner, Mountain and D'Ambrumenil Ltd v Inland Revenue Commissioners - (1947) 177 LT 16; [1947] 1 All ER 650; 29TC69
Harrison v John Cronk and Sons Ltd - [1937] AC 185; [1936] 3 All ER 747
Newcastle Breweries Ltd v Inland Revenue Commissioners - (1927) 96 LJKB 735; 12 TC 927
Southern Railway of Peru Ltd v Owen - [1957] AC 334; [1956] 3 WLR 389; [1956] 2 All ER 728
Sun Insurance Office v Clark - [1912] AC 443
Bennett v Ogston - (1930) 15 TC 374
Dailuaine-Talisker Distilleries Ltd v Inland Revenue Commissioners - [1930] SC 878; 15 TC 613
Dimbula Valley (Ceylon) Tea Co Ltd v Laurie - [1961] Ch 353; [1961] 2 WLR 253; [1961] 1 All ER 769
Odeon Associated Theatres Ltd v Jones - [1971] 1 WLR 442; [1971] 2 All ER 407; [1973] Ch 288; [1972] 2 WLR 331; [1972] 1 All ER 681
Pearce v Woodall Duckham Ltd - [1977] 1 WLR 224; [1977] 1 All ER 753
Seaham Harbour Dock Co v Crook - (1930) 16 TC 333
Whitworth Park Coal Co Ltd v Inland Revenue Commissioners - [1961] AC 31; [1959] 3 WLR 842; [1959] 3 All ER 703

Hearing date: December 7 - 8 1977; February 2 1978
Judgment date: 2 February 1978

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Judgment by:
Lord Fraser of Tullybelton

My Lords, this appeal is concerned with the question of how gains accruing to the respondent bank ("the bank") from the discounting and purchase of bills and notes in the course of its business should be taken into account in computing its profits for purposes of corporation tax. The bank's accounts prepared for commercial purposes take account of such gains by bringing into the profit and loss account for each year a proportionate part of the difference between the price paid for each bill and its value at maturity. But the bank maintains, at first sight perhaps rather surprisingly, that accounts prepared in that way conflict with the principle of income tax law that profits may not be anticipated, and therefore that they cannot be used for purposes of corporation tax. The Crown maintains the contrary. The general commissioners for the City of London decided in favour of the bank. Walton J. dismissed an appeal by the Crown by way of stated case, and the Court of Appeal by a majority (Ormrod L.J. and Sir John Pennycuick, with Stamp L.J. dissenting) dismissed a further appeal.

[His Lordship stated the facts and set out the bank's method of dealing with the discount on the bills in its annual accounts and continued:] The amounts thus taken into account have been referred to as "accrued discount" or "earned discount" but these are no more than convenient shorthand descriptions and they are obviously not accurate, for discount, unlike interest, does not accrue and is not earned, and I think the expressions are apt to be misleading.

It is well established that "the question of what is or is not profit or gain must primarily be one of fact, and of fact to be ascertained by the tests applied in ordinary business" - Sun Insurance Office v. Clark [1912] A.C. 443, 455 per Viscount Haldane. But that general rule is subject to the exception that where ordinary commercial principles run counter to the principles of income tax they must yield to the latter when computing profits or gains for tax purposes. In B.S.C. Footwear Ltd. v. Ridgway [1972] A.C. 544, 552G Lord Reid said:

"The application of the principles of commercial accounting is, however, subject to one well-established though non-statutory principle. Neither profit nor loss may be anticipated. A trader may have made such a good contract in year one that it is virtually certain to produce a large profit in year two. But he cannot be required to pay tax on that profit until it actually accrues."

Lord Morris of Borth-y-Gest at p. 560E quoted from the speech of Lord Reid in Duple Motor Bodies Ltd. v. Inland Revenue Commissioners [1961] 1 W.L.R. 739, 751 the statement that "... it is a cardinal principle that profit shall not be taxed until realised." The bank maintains that that cardinal principle would be contravened in the present case if it were compelled to pay corporation tax on the basis of its accounts prepared for commercial purposes.

Mr Nolan on behalf of the Crown relied on the general rule that the principles of commercial accounting should normally prevail. But that rule is of little or no assistance to his argument, because the method in which the bank's accounts were drawn up was not the only method that would be in accordance with sound principles of commercial accounting. The effect of the auditor's evidence to the general commissioners was that if the bank's commercial accounts had been prepared in a manner so as to exclude so-called accrued discount (that is, in the manner that would accord with what the bank maintains are the principles of income tax law) that would not have been in accordance with the procedure customarily adopted by the clearing banks. But because the business of this bank differs materially from that of a conventional clearing bank the auditors would have signed their report on the accounts so prepared without qualification, "provided that the procedure which had been followed had been fully explained in those accounts." That means that accounts which excluded "accrued discount" would have given a "true and fair view" of the state of the bank's business and would have been just as satisfactory for commercial purposes as the accounts that were in fact prepared. The reason for including an express explanation would have been not that the procedure was less acceptable than that actually used, but only that it differed from that used by the clearing banks.

Mr. Nolan also said that the accounts as prepared for commercial purposes have the practical advantage that they show in each year on the debit side the interest paid by the bank on money borrowed by it and on the credit side the "accrued discount" earned by using the borrowed money. If, and insofar as, the bills are purchased with the bank's own funds, the "accrued discount" takes the place of the interest that might have been earned by investing or lending the money. Accounts prepared in that way thus show the contribution of this part of the bank's business towards the balance of profit and loss in each year. If on the other hand nothing is taken into account on the credit side until each bill matures the accounts for the years during which a bill is held understate the profits. That is perfectly true, but, as it is not the only method that is commercially satisfactory, it does not assist his argument.

The solution to the problem depends in my opinion upon the true nature of what the bank is doing when it discounts or purchases a bill. In my view it is acquiring an asset and, so long as it continues to hold that asset, it does not, and cannot, realise any profit or loss in respect of it. If the bank takes credit for any "accrued discount" while it is still holding the bill, it is therefore anticipating a profit that has not yet been realised. If the bills were ordinary commodities, there can be no doubt that that would be the position, and I cannot see that it makes any difference for this purpose that the bills were for fixed sums of money. Of course the fact that the money value at maturity is fixed means that the bank could ascertain in advance the profit that it would make if a bill is held to maturity. But we know that it quite often did not do so but sold bills before maturity. In such cases the realised profit would be unlikely to be exactly the same as the profit expected on maturity, and the sale might even be at a loss. Even where bills were held to maturity a substantial number of them were in currencies other than sterling and fluctuations in the foreign exchange rates would therefore affect the sterling value and the profit on maturity of such bills.

Stamp L.J. reached his conclusion in favour of the Crown by accepting the submission [1977] Ch. 78, 87B, "that there is no distinction in principle between earning interest and earning discount." With respect I cannot agree with that view. In my opinion there is an essential difference between interest and discount, so much so that to speak of "earning" discount, seems to me wrong. Interest accrues from day to day, or at other fixed intervals, but discount does not. Two consequences follow.

Firstly, when periodical interest is received (or is due to be received) the profit or gain on the loan is realised from time to time. But when a bill is discounted nothing is realised until the bill matures or is sold, and the whole profit is postponed or rolled up until one of these events occurs. That accords with the finding of the general commissioners to the following effect:

"We find on the evidence before us that it was not possible for the bank to realise before maturity the discount on the discounted bills and notes otherwise than by sale on the market."

Secondly, it is possible to calculate, if necessary in advance, the interest that is, or will be, due at any date while the bill is outstanding, and therefore to calculate the profit as at that date. But when a bill is discounted no such calculation is possible; the general commissioners summarised the evidence of experts on this point as follows:

"Current prices of discounted bills are affected by the risk involved in rates of interest which are subject to wide fluctuations. The amount of profit a purchaser or discounter of a bill may make is not ascertainable before the bill (a) is sold or (b) reaches maturity."

In these circumstances I agree with the conclusion of Walton J. that when the bank brought part of the "accrued discount" into its accounts during the currency of a bill it was anticipating a profit which had not yet been realised.

The view that I take does not involve any departure from an earnings basis in favour of a cash basis of accounting. The repayment value of each bill will, if I am right, be brought into its accounts at the date on which it is due for repayment, and not at the date at which it is actually repaid if that is later than the due date. We were much pressed with the speech of Lord Radcliffe in Southern Railway of Peru Ltd. v. Owen [1957] A.C. 334, 354 which includes this passage:

"The courts have not found it impossible hitherto to make considerable adjustments in the actual fall of receipts or payments in order to arrive at a truer statement of the profits of successive years. After all, that is why income and expenditure accounting is preferred to cash accounting for this purpose. As I understand the matter, the principle that justified the attribution of something that was in fact received in one year to the profits of an earlier year, as in such eases as Isaac Holden & Sons Ltd. v. Inland Revenue Commissioners (1924) 12 T.C. 768 and Newcastle Breweries Ltd. v. Inland Revenue Commissioners (1927) 96 L.J.K.B. 735 was just this, that the payment had been earned by services given in the earlier year and therefore a true statement of profit required that the year which had borne the burden of the cost should have appropriated to it the benefit of the receipt. The principle is clearly stated in a speech of Lord Simon in Gardner, Mountain and D'Ambrumenil Ltd. v. Inland Revenue Commissioners (1946) 177 L.T. 16, 19 and I take leave to quote his words: 'In calculating the taxable profit of a business on income tax principles ... services completely rendered or goods supplied, which are not to be paid for till a subsequent year, cannot, generally speaking, be dealt with by treating the taxpayer's outlay as pure loss in the year in which it was incurred and bringing in the remuneration as pure profit in the subsequent year in which it was paid, or is due to be paid.'"

These observations by Lord Radcliffe and Lord Simon do not appear to me to bear upon the point that is at issue here. When the bank purchases or discounts a bill it does not, except in a very loose sense, render services to the borrower; it acquires an asset. Accordingly no payment has been "earned by services given in the earlier years" (i.e. years between the date of purchase of the bill and its maturity) nor are any "services completely rendered" then.

It may be suggested that the view that I have taken depends upon an unduly exact analysis of the legal form of the transaction of purchasing bills and that it is inconsistent with a later passage in Lord Radcliffe's speech in the Southern Railway of Peru case where he said, at p. 357:

"The answer to the question what can or cannot be admitted into the annual account is not provided by any exact analysis of the legal form of the relevant obligation. In this case, as in the Sun Insurance case [1912] A.C. 443, you get into a world of unreality if you try to solve your problem in that way, because, where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision."

But in that passage Lord Radcliffe was referring to provisions for contingent liability and nothing of that sort arises in the present case. There is no question of entering a world of unreality if receipts for bills are taken into account when the bills are mature and due for repayment rather than by being anticipated during the currency of the bills.

I can see that there might be a case for taking bills into account as receipts on the dates when they are purchased, at values discounted by reference to the date of maturity, like the deposits with the building society in Harrison v. John Cronk and Sons Ltd. [1937] A.C. 185. I do not know how the values discounted in that way would compare with the sums paid by the bank for acquiring the bills and it is not necessary to pursue the matter as no argument was advanced in favour of this method.

For these reasons I am of opinion that the bank's accounts prepared for commercial purposes are drawn up on the principle of anticipating future profits from its holding of bills and notes. There are no doubt excellent commercial reasons for preparing the accounts in that way if I may borrow the words of Walton J. [1976] 1 W.L.R. 657, 663C, they

"are much better economic indicators than corporation tax accounts would be as to whether a bank is or is not doing what it ought to be doing, that is to say, steadily making an economic profit for its shareholders."

But they are not a proper basis for assessing the bank's liability to corporation tax.

The bank has an alternative case, based on the contention that the bills and notes were their stock-in-trade. As there is no finding on this point by the general commissioners, I do not think that we could have dealt with it without remitting the case to them. But if my view is right, the point does not have to be decided.

I would dismiss the appeal.