Anise Ltd & Ors v HM Inspector of Taxes  [2003] UKSC SPC00364 (24 March 2003)

SCHEDULE D – Trading profits – Moneys mistakenly paid to trader – Appellants supplied 
advertising facilities to customers – Customers mistakenly paid more than invoiced amounts – overpaid amounts accounted for by appellants as “creditors” but after two years transferred to profit and loss account as exceptional items – whether overpayments constitute trading receipts accruing or arising from trade for tax purposes - No

THE SPECIAL COMMISSIONERS

ANISE LIMITED
BASIL LIMITED
CHIVE LIMITED
	DILL LIMITED	Appellants

	- and -

	STUART HAMMOND (HM INSPECTOR OF TAXES)    	Respondent

		Special Commissioners:  STEPHEN OLIVER QC
					      DR DAVID WILLIAMS	

					 	

Sitting in London on  11 February 2003

Hugh McKay, counsel, instructed by Turner and Brown, chartered accountants for the appellants  

Ian Jarman, HM Inspector of Taxes, for the Respondent

© CROWN COPYRIGHT 2003

ANONYMIZED DECISION

1	The four appellant companies appeal against corporation tax assessments in respect of their trading profits for their accounting periods ending 31 December 1993.  The appellant companies are Anise Limited, Basil Limited, Chive Limited and Dill Limited.   They are all members of the same group of companies.

2	The four appellant companies, to whom we refer collectively “the members of the Trading Group” or as “the Trading Group”, all carried on similar businesses selling advertising space in brochures and supplying those brochures free of charge to users. That was the central business of those member companies and of the group. The issue in the case is whether sums of money mistakenly paid to those members of the Trading Group by customers or the paying agents of customers, and not repaid by those companies to those customers or paying agents, were subject to corporation tax. If they were, the second issue was in what year the sums fell to be taxed.

The facts

3	The primary facts were not in dispute before us. The Group Finance Controller of the Trading Group gave evidence before us in confirmation of specimen transactions, but in our view nothing turns on the individual details of transactions.  On that basis, we find the following to be the relevant facts.  

4	The business of each of the member companies in the Trading Group was that of publishing and circulating brochures and booklets containing advertising for which the companies were paid by advertisers. This was a profit-making business in the years in question for each company. It was not contended before us that the companies were engaged in any other relevant business activity. 

5	The payments about which the appeals are concerned arose as follows. The members of the Trading Group all adopted a similar method of securing payment for the advertisements they produced and published. When a representative of a member company identified an advertiser, the advertiser was asked to sign a contract confirming the agreement and arranging for payment in a standard fashion. The standard terms were that payment was made in three stages. At the time the contract was signed the customer paid the representative a cheque by way of deposit for the advertising services. Typically, the amount of the cheque would be 17.5% of the net contract price. In effect this represented the value added tax that would apply to the price of the agreement. Again typically, the customer was asked to fill in a banker’s order to make two equal payments for the price of the advertisement to be provided (net of VAT). The first half payment was due and payable seven days after the customer approved a proof copy of the advertisement. The second half payment was due one year later. The significance of the two-year period was because most of the publications produced by the Trading Group had an effective life of two years before a new issue. 

6	Experience showed that the members of the Trading Group received excess payments under some standing orders. This might be by error of the customer or of the customer’s bank. It was not alleged that the member companies engaged in activities that would cause or facilitate these errors by others. When erroneous payments were received, the members of the Trading Group accounted for the overpaid sums as creditors on the basis that they were repayable to the bank or other paying agent that paid the member. If an overpayment was claimed back, it was repaid subject to an administration charge. 

7	Until the financial year ending 31 December 1992, overpayments that had not been claimed back remained as creditors in the accounts until they were six years old. After six years they were written to the profit and loss account. As such they were included in the taxable profits of the member company.

8	From the start of the financial year on 1 January 1993 the members of the Trading Group, acting on the advice of their accountants, took two different views of the overpayments. First, the view was taken that the overpaid sums were not taxable receipts. This was because they were not trading receipts. Second, the view was taken that the overpaid sums should, on the basis of reclaims experience, be transferred to the profit and loss account after two years, not six years as before. To give effect to the new policies, overpayments for the years from 1 January 1987 to 31 December 1990  were written into the profit and loss accounts for the accounting year 1993 as an exceptional item, and the two-year-old overpayments were written into the profit and loss accounts as non-trading receipts. The sums were shown in the accounts of the members as non-trading receipts and in the corporation tax computations for 1993 and subsequently in the same way. The adjustments made in 1993 were included in the accounts of each member as an “exceptional item” and shown in the computation as non-taxable. 

9	The Trading Group received considerable numbers of overpayments during 1993 and thereafter. A detailed schedule produced to us of the overpayments received by one member company shows that in many cases the sums were refunded to the bank or customer, but in many cases they were not. The overpayments also did not arise for a single reason. Some appear to be payments made monthly rather than annually, and some appear to be payments of wrong amounts. Others appear to be paid on dates that have no obvious relation to the payments properly made. The more common form of overpayment was a single excess payment after the two annual payments had been made – sometimes several years later. There is, again, no pattern to the overpayments that were refunded, save that refunds were made in most cases of multiple overpayment. 

10	The scale of the overpayments received varied from one member company of the Trading Group to another. One member company, however, received excess payments of £62,900 in the trading year to 31 December 1993, and entered an exceptional item of £199,602 into its profit and loss account when it reduced the period of holding overpayments from six years to two years. No information was available about whether the member company had subsequently refunded any of those overpayments following subsequent demands for their return. 

11	We find on the evidence that these payments were sums of money to which, on receipt, the member companies were not entitled. They had not sought them, and they did not arise from any contractual link between the member company and the payer. Nor did the member companies regard the sums as money to which they were entitled on receipt. If a refund was requested (and sometimes the request was invited) then it was made, subject to the administration charge. Further, it was not clear that the customers themselves were always aware of the overpayments, or bore the cost of them, as they might be occasioned by faulty procedures by the banks and building societies that acted as the paying agents for the bankers’ orders.  We emphasise that there is no suggestion that the member companies were conducting their business so as to receive the overpayments. That was not part of their trade. 

12	We therefore conclude that the overpayments were not received as part of the terms of trade of the member companies. They did not arise as a direct consequence of the trading relationships between the Trading Group and its customers.  	

13	The Inspector of Taxes took the view that all the sums representing overpayments should be included in the taxable receipts of the members of the Trading Group at an appropriate date, and the taxpayers appealed. The case was heard by us on the issue of principle. 

The relevant legislation 

14	Hugh McKay for the Trading Group introduced the case as an old-fashioned tax appeal concerned with basic principles. The question for each of the taxpayers, in each year in question, was whether the overpaid sums taken to the profit and loss account were, or were not, trading income within Case I of Schedule D of the income tax (as applied to corporation tax).

15	The relevant provision is in section 18(1) to (3) of the Income and Corporation Taxes Act 1988 which, so far as relevant, provides:

(1)	Tax under this Schedule shall be charged in respect of –

(a)	the annual profits or gains arising or accruing –

	(i)	to any person residing in the United Kingdom from any kind of property whatever, whether situated in the United Kingdom or elsewhere, and

	(ii)	to any person residing in the united Kingdom from any trade, profession or vocation, whether carried on in the United Kingdom or elsewhere …

(2)	Tax under Schedule D shall be charged under the Cases set out in subsection (3) below, and subject to and in accordance with the provisions of the Tax Acts applicable to those Cases respectively.

(3)	The Cases are –

	Case I	-  tax in respect of any trade carried on in the United Kingdom     or elsewhere …

16	For the sake of completeness, as the taxpayers are companies liable to corporation tax, section 9(1) and (3) of that Act should also be noted:

(1)	Except as otherwise provided by the Tax Acts, the amount of any income shall for purposes of corporation tax be computed in accordance with income tax principles, all questions as to the amounts which are or are not to be taken into account as income, or in computing income, or charged to tax as a person’s income, or as to the time when any such amount is to be treated as arising, being determined in accordance with income tax law and practice as if accounting periods were years of assessment.

…

(3)	Accordingly, for purposes of corporation tax, income shall be computed, and the assessment shall be made, under the like Schedules and Cases as apply for the purpose of income tax …

17	No other statutory provisions were cited to us or appear relevant to the case.

Were the overpayments trading receipts? 

18	The main question of principle before us was whether, on the facts, the sums transferred to profit and loss account from the overpayments were “annual profits or gains arising or accruing … from any trade” and therefore taxable under Case I of Schedule D (with or without deductions). The Trading Group contended that the transferred overpayments were not annual profits or gains, as they arose after the trading connection between the member companies of the Trading Group and their customers had ended. Nor could the receipts become trading receipts at any later stage. The Inspector of Taxes, represented by Ian Jarman,  contended that the sums were taxable as annual profits or gains because they arose from the companies’ trades, although he was less specific about the year in which the sums arose or accrued.   

19	Mr McKay founded his argument on the decision of the Court of Appeal in Morley(Inspector of Taxes) v Messrs Tattersall (1938) 22 TC 51. This confirmed the principle that sums either were or were not trading receipts at the time they were received. The nature could not change after receipt. He distinguished from that case the decision of Atkinson J in Jay’s the Jewellers Ltd v Commissioners of Inland Revenue (1947) 29 TC 274.

Morley v Tattersalls

20	Tattersalls concerned whether the taxable profits of the racehorse auctioneers, run as a partnership, should include sums transferred to the partners from unclaimed balances of sale proceeds of racehorses sold by them. As auctioneers, Tattersalls received the agreed purchase price of a racehorse they had sold from the purchaser. The sale commission earned by Tattersalls was deducted along with any expenses due and the balance transferred to the seller of the racehorse when the seller asked for it. From time to time sellers neglected to send written orders to Tattersalls for payment of purchase moneys owed to them. These sums built up and were transferred to the partners on two occasions, in 1921 and 1934. On an appeal from an assessment to income tax, the Special Commissioners held that the unclaimed balances were not trading receipts under Case I of Schedule D. Lawrence J allowed an appeal, and the matter was further appealed to a Court of Appeal consisting of Sir Wilfred Greene MR, Scott LJ and Clauson LJ.

21	Sir Wilfred Greene MR gave the judgment of the Court. Before the Court, the Inland Revenue sought to support the decision of Lawrence J on two separate grounds, both of which were rejected. The first of the arguments was advanced by Mr Hills. It was dismissed in the following terms by the Master of the Rolls (22 TC 51, 65):

“Mr Hills’ argument was to the effect that, although they were not trading receipts at the moment of receipt, they had at that moment the potentiality of becoming trading receipts. That proposition involves a view of income tax law in which I can discover no merit except that of novelty. I invited Mr Hills to point to any authority which in any way supported the proposition that a receipt which at the time of its receipt was not a trading receipts could by some subsequent operation ex post facto be turned into a trading receipt, not, be it observed, as at the date of receipt, but as at the date of the subsequent operation. It seems to me, with all respect to that argument, that it is based on a complete misapprehension of what is meant by a trading receipt in income tax law. No case has been cited to us in which anything like that proposition appears. It seems to me that the quality and nature of receipt for income tax purposes is fixed once and for all when it is received. What the partners did in this case, as I have said, was to decide among themselves that what they had previously regarded as a liability of the firm they would not, for practical reasons, regard as a liability; but that does not mean that at that moment they received something, nor does it mean that at that moment they imprinted upon some existing asset a quality different from what it had possessed before. There was no existing asset at all at that time. All they did, as I have already pointed out, was to write down a liability item in their balance sheet, and how in the world by effecting that operation you can be said to have converted a sum received years ago into something which it never was is a thing which, with all respect, passes my comprehension.”

 His Lordship went on to dismiss as irrelevant the one authority cited by Mr Hills to support his argument.  
 
22	The other argument for the Inland Revenue was advanced by the Solicitor General (Sir Terence O’Connor KC).  He argued that a proportion of the sums received each year were going to remain unclaimed, and that it was permissible to regard that proportion as a trading receipt of the partners. Sir Wilfred Greene, dismissed this argument shortly as “completely devoid of foundation”. The amounts said to have been received in this way were “a figment of the imagination”. It also meant that the Crown would be unable to quantify the taxable income in the year in which it was received. He then rehearsed and disagreed with the judgment of Lawrence J.  

23	Mr McKay submitted that the principle emphatically endorsed in that case that payments either were or were not trading receipts when received, and did not change their quality later, applied also in this case. His clients did not receive the sums as trading receipts. They could not become trading receipts at any later date simply because his clients decided at some time to transfer the sums from credit account to the profit and loss account, or for any other reason. 

Jays – The Jewellers v Commissioners of Inland Revenue

24	The one case that stood against that view was Jay’s the Jeweller. That case concerned the composite trade of pawnbroking, namely the trade of money lending and the sale of pledged goods. Those activities were regulated by statute, and the terms of the statute dictated when a pawnbroker could sell pledged goods and under what terms the pawnbroker could keep any surplus realised on a sale of pledged goods. In that case, the Special Commissioners rejected the contention of the Crown that the surplus on sale of pledges was a receipt of the taxpayer’s trade at the time it was received, subject to the contingent right of the pawner or borrower to be paid any surplus under the terms of the statute. They found that the surplus was a receipt of the business when the taxpayer became absolutely entitled to the sums by law. The Tattersalls case was distinguished because the special property that the pawnbroker had in the pledges was quite different to the rights of an auctioneer in items sold for customers, and no statutory provisions were relevant to the sums held by Tattersalls.

25 	Atkinson J confirmed the decision of the Special Commissioners.  He noted that it was common ground that the proceeds from some sales of pledges were trading receipts in the year of receipt. As to other receipts from these sales, the Crown challenged before him the conclusion that those other receipts were not trading receipts when received, while the taxpayer challenged the findings that those other receipts were taxable as trading receipts when the taxpayers became fully entitled to the proceeds. His Lordship also noted that the profit made from unclaimed surpluses on sales of pledged goods was the most profitable part of the business. 

26	 In his judgment, Atkinson J stated that “I cannot see any principle on which the Crown can claim that surpluses are trade receipts in the year in which they come into existence” (at p 283), and he relied on the Tattersalls decision for that proposition. He then moved to considering if the sums became trading receipts when the taxpayers became fully entitled to them. He agreed with the basis of the Special Commissioners’ conclusion that the sums became trading receipts when the taxpayers became fully entitled to them. In the year in which the taxpayers became entitled to the sums they transferred them from a suspense account they became trading receipts. “In that year Jay’s the Jeweller become the richer by the amount which automatically becomes theirs, and that asset arises out of an ordinary trade transaction” (at p 286).  Tattersalls was to be distinguished because in this case, unlike that case, at the end of the three year period under the relevant legislation the money in question attained a different quality and there was then a trade receipt. “At the end of the three years a new asset came into existence, an asset which had arisen out of a trade transaction, and it seems to me that what the Master of the Rolls was dealing with in that case was  a situation quite different from that which exists here” (at p. 287). 
 
27	On that basis, Mr McKay argued that Tattersalls provided the starting and finishing point in this case. The overpaid sums were not received as trading receipts. They did not arise from trading transactions. They were not subject to any special regime as occurred in Jay’s the Jeweller. They did not at any stage become trading receipts. 

The submissions of the Inspector

28	Mr Jarman  did not seek to reanalyse the authorities. In his view the case was straightforward. The treatment of the overpaid sums before 1993 was correct. They were treated as trading receipts when they were removed from the creditors accounts to the profit and loss account. The sums received arose because of the trade of the member companies as publishers, and the source of the income was in each case the contracts with the customers. The reason why a particular overpayment occurred was irrelevant. The relevant point was that it was retained by the member company. 

29	Mr Jarman did not dispute the principle in Tattersalls. He submitted that the character of these overpayments was that of trading receipts at the time of receipt. The question was when they fell to be taxed, given that some overpayments would be refunded. On that, he was content with the companies’ treatment. If they took the sums to profits after two years, then the Revenue would accept that. If they reverted to six years, again the Revenue would accept that.  He acknowledged that the individual sums did not arise under the contracts with customers and were not covered by any  terms of the trade. But they did arise from them in the sense that they derived from the trading relationships with customers. He also accepted that the position would be the same if the case related to a single large overpayment. He was not contending that the fact that there were recurring smaller overpayments made the receipt of those overpayments part of the business of the taxpayers. 

The nature of the overpayments

30	We agree with Mr McKay that the relevant principle here is that laid down in Tattersalls.  It must be determined whether these overpayments were, or were not, trading receipts at the time they were received. We find as fact that they were not received as part of the trading activities of the member companies of the Trading Group. That brings the overpayments fully within the principle laid down in Tattersalls, and distinguishes them from the approach taken in Jay’s the Jeweller, where it was accepted that the surpluses did arise directly from the trading activities of the taxpayer. In this connection the reason for the overpayment was not irrelevant. We have placed reliance on the fact that seeking the overpayments was not a trading activity of the taxpayers. That again distinguishes the present case from Jay’s the Jeweller,  where the retention of the surpluses was the most profitable part of the business and was fully authorised by law. On that basis, we reject the submission of the Inspector that the sums were received as trading receipts.

31	If that were so, could the sums become trading receipts at some later stage? On that we again follow Tattersalls and not Jay’s the Jeweller. The Inspector was content to tax the overpayments when they were transferred after two years from the creditors account to the profit and loss account. We see no basis for such a charge. That was a purely internal transaction within each company. Unlike the view taken by Atkinson J on the facts in Jay’s the Jeweller, there was no trading asset created here. It was not argued before us that the Limitation Acts could create such a change. Nor, as we have stated, were we given evidence as to why the individual overpayments arose or to whom the unclaimed overpayments were due. That, in our view, would be necessary to any analysis based on the Limitation Act, as would a basis for defining when time started to run. But even if, in course of time, the overpayments became irrecoverable under the Limitation Acts, that does not bring the payments within the approach taken in Jay’s the Jeweller. In that case it was accepted that the receipt of the surpluses was part of the trade of the taxpayer, and the issue was when those sums became “trading receipts” for excess profits tax purposes. In this case, whether or not the receipts could for other purposes be regarded as assets or as some other kind of income,  we do not accept that the overpayments were received as part of the trade of the member companies. They therefore were not and did not become trading receipts. 

32	For those reasons we determine the point of principle in the Appellants’ favour.

Stephen Oliver

David Williams

SPECIAL COMMISSIONERS

Cases cited but not referred to in the decision
Murray v Goodhews (1977) 52 TC 86
Rolfe v Nagel (1981) 55 TC 585
Commissioners of Income Tax v Savundranayagam (1957) 67 TC 239
IRC v Falkirk Ice Rink (1975) 51 TC 42

SC 3045/02