SOTHERN-SMITH Vs. CLANCY

JUDGEMENT

(1.) The case has throughout been conducted upon the footing that the respondent, although she was not a party to the contract, is entitled in law to claim from the society the sums which it is agreed to pay to her. It may be that this is in accordance with the law of the State of New York by which the contract would seem to be governed. The assessments were made under Case III of Schedule D, and the relevant provisions of the Income Tax Act, 1918, are as follows : "Schedule D. 1. Tax under this Schedule shall be charged in respect of..... (b) All interest of money, annuities and other annual profits or gains not charged under Schedule A, B, C, or E and not specially exempted from tax.... for every twenty shillings of the annual amount of the profits or gains. 2. Tax under this Schedule shall be charged under the following cases respectively; that is to say..... Case III. Tax in respect of profits of an uncertain value and of other income described in the rules applicable to this Case;" "Rules applicable to Case III, 1. The tax shall extend to - (a) .... any annuity or other annual payment whether such payment is payable within or out of the United Kingdom....." It is clear that an annuity or other annual payment falls to be struck with tax as being an "annual profit or gain", and this is the reason why it becomes necessary to examine the nature of an annual payment in order to see whether it is in truth an income or a capital payment-a question which cannot be answered merely by pointing to the fact that it is annual. Questions of this kind are notoriously difficult and give rise to distinctions of a highly artificial character. The present case is no exception.

(2.) It is no doubt true to say that in order to answer the question the real nature of the transaction must be ascertained. This proposition has an engaging appearance of simplicity; but it is not so simple as it sounds. For the expression "the real nature of the transaction" is ambiguous. It may mean the real nature of the legal relationship of the parties which results from the transaction - a matter which may not be in doubt; or it may include as well the real nature of the transaction from a financial point of view-a matter which at once raises a number of difficulties. If the transactions be one under which A, being or becoming indebted to B for a sum of pound 1,000, agrees with B to repay this sum by ten yearly instalments, or if A, being the purchaser of property from B for pound 1,000, agrees to pay the purchase price by ten yearly instalments, the real nature of the transaction from the legal point of view is that A is contracting to pay by instalments in the one case a debt and in the other a purchase price. In such cases the very nature of the legal relationship constituted by the contract prevents the annual payments from being anything but payments of capital. If to the instalments there is added an element of interest, that element would presumably attract tax as being an annual profit or gain. This would appear to be the result of Scoble V/s. Secretary of State in Council of India (1903) 4 Tax Cas. 618 and Perrin V/s. Dickson (1930) 14 Tax Cas. 608, although in Foley V/s. Fletcher (1858) 28 L.J. Ex 100; 3 H & N 769 the opposite view was expressed. But in other cases the real nature of the transaction from the legal point of view does not of necessity stamp it as a capital transaction. Let me take the simple case of a contract under which in consideration of a single payment by B, A agrees to pay to him an annuity for a period of years. The legal nature of such a contract is beyond question. The property in the said sum paid by B passes absolutely to A; no relationship of debtor and creditor with regard to that sum is ever constituted. The sum as a sum ceases to exist once it is paid. Its place is taken by As promise to pay the annuity, and Bs only right is to demand payment of the annuity as it accrues due. If A repudiates the contract, B may sue for damages, the measure of damages being the sum of the payments still remaining to be paid, subject to discount. Is it then permissible to look behind the legal nature of the transaction and inquire into its financial nature ? If this is done, it is at once apparent that the annual payments are calculated on the basis that at the expiration of the period of the annuity B will have received an amount equal to the sum which he paid together with a sum in respect of interest, for it is on that basis that in such a transaction the amount of the annual payments is calculated. That this is so will be self-evident from the figures themselves. It may even be stated in terms. The financial result of the transactions is therefore clear : at the end of the period B will have received an amount equal to his capital, plus a certain addition for interest, and if each annual payment is struck with tax he will in one sense be paying tax on capital. Nevertheless, it has throughout been assumed by the Courts that such payments are liable to tax. (See for example Coltness Iron Co. V/s. Black (1881) 1 Tax Cas. 287, Jones V/s. Commissioners of Inland Revenue (1920) 7 Tax Cas. 310, and Perrin V/s. Dickson (1930) 14 Tax Cas. 608. The reasoning in Scobles Case (1903) 4 Tax Cas. 618 seems to be based upon the same view).

(3.) In Perrin V/s. Dickson (1930) 14 Tax Cas. 608, on the other hand, this Court felt itself at liberty to hear extrinsic evidence as to the method of calculating the payments which feel to be made, and upon the facts so ascertained, coupled with a particular term of the contract, to hold that they were of a capital nature. I must confess that I find the reasoning of the judgments in that case difficult to follow. In the events which happened the liability to make the annual payments became effective, and in that aspect of the matter the case did not differ from the ordinary case of the purchase of an annuity for a period of years. The method of calculating the annual sums was apparently regarded as of importance; but it can scarcely have been regarded as decisive, because the same method is used in the ordinary case of an annuity for a period of years, and Lawrence, L.J., at any rate did not regard himself as deciding that such an annuity would not be taxable. The other important element in the case was the undertaking of the insurance company to repay in an event which did not happen the whole or part (as the case might be) of what had been paid by way of premium. This seems to have led the Court to regard the whole transaction as similar to that of a loan repayable by instalments or (in one event) in a lump sum. My difficulty here is that the transaction certainly was not a loan transaction, although I could better have understood an argument to the effect that it was a transaction which, in the event which did happen, was the purchase of an annuity and in the event which did not happen was in substance the repayment of the whole or part of what had been paid.