BIM37820 - Wholly & exclusively: expense of earning or application of profits?: rent subject to abatement of profits
Rent paid to overseas landlord and subject to restriction in the event of insufficient profits
The rent of business premises is allowable to the extent that
the premises are used for the purposes of the trade, profession or
vocation.
In the case of Union Cold Storage Co Ltd v Adamson [1931]
16TC293, the company traded both in the UK and also extensively
abroad. The company was controlled by members of the Vestey family
with only a minority public holding of shares and debentures. The
Vesteys owned or were beneficially interested in, or controlled
though various companies, numerous overseas properties occupied by
Union Cold Storage Co Ltd. The properties were leased to Union Cold
Storage Co Ltd for 21 years at a rental of about £1m per year.
The leases were terminable at 6 months notice by either side (there
was no expectation that such notice would be given). To safeguard
the outside investors there was a clause providing that if, after
making the rental payments, the profits were insufficient to meet
the interest on charges and debentures and to pay a 10% ordinary
dividend the rent was to be reduced by the amount of this
deficiency; and the lessors were to repay any amounts thereby
overpaid. The rent was settled on trustees resident in Paris with
consequent tax advantages. This circumstance aroused suspicion that
the scheme was one of tax avoidance rather than bona fide rent.
Union Cold Storage Co Ltd claimed a deduction for the rent
actually paid. The Commissioners disallowed the deduction on the
basis that the rent was contingent upon and payable only out of
profits earned. The Courts unanimously reversed this decision. The
arrangement for abatement in the event of low profits did not alter
the nature of the payment, which remained a real payment of rent.
This was an expense of earning the profits not an application out
of the profits and was therefore an allowable deduction.
In the High Court Rowlatt J explained that the rent was
deductible because it was an ordinary outgoing of the business,
16TC upper half of page 318:
The Company is in possession of all these premises abroad; it does not own them, but it has obtained possession and the use of them under this arrangement and it has to make some recompense in respect of that possession and use. I have used that lengthy form of expression because both sides are so afraid that I should, somehow or other, be hypnotised by the word ‘rent’. This is simply a sum, which the Company have entered into some liabilities about, by way of payment for their premises and, whatever you call it, a payment of that kind is, prima facie, most certainly an outgoing of the business which has to be provided for and allowed before you can see whether the incoming of the business exceeds the outgoing and so shows a profit. That is quite clearly the ordinary way in which an expense of this kind must be looked at.
In the Court of Appeal the Master of the Rolls, Lord Hanworth, after saying that the issue was a mixed question of fact and law said that the case depended on the interpretation of the lease, 16TC at the foot of page 322:
…it is important to bear in mind that it is not alleged by the Crown that this indenture of lease is not a valid and effective document, a specious device or strategy to cloak the true facts; it is accepted as a good agreement, and that carries one a very long way; it is no use to say the lease must be accepted as a lease, but must be looked at with the eye of suspicion; you have got to take its terms, and I think Mr. Justice Rowlatt is right in saying that once the Crown have admitted that it is a real document, then the case has to be decided upon the tenor of the document as it stands…
Romer LJ, also took the view that the issues involved were a mixed question of law and fact, and were therefore open to review by the courts, 16TC foot of page 327 to middle of page 328:
Now it seems to me impossible to come to the
conclusion that these sums were not paid by the Company for the
purpose of enabling them to carry on and earn profits in that
trade. The sums were paid for the acquisition and possession of
what were essential for the Company in order to enable it to earn
part of the profits which the Crown were now seeking to tax.
I agree that the question does not rest there,
because although those payments may have been, and in my opinion
clearly were, made for the purpose of enabling the Company to carry
on and earn profits in the trade, the sums so paid may nevertheless
have been paid out of the profits of the Company, within the
meaning of [what is now ICTA88/S74 (l)].
Approaching that question, it appears to me
that inasmuch as the Crown do not attack the bona fides of the
document of 1921, the document which has been called, and I think
is, a lease or agreement for a lease, they do not regard it as a
mere cloak or sham, in order to succeed in their contention that
the payments were really payments of profits, they must establish
the following proposition: That where a company, for the purpose of
enabling it to carry on its trade and earn profits in its trade,
places itself under an obligation to make money payments, the
amount of which is dependent upon the profits earned, or the
payment of which is contingent upon certain profits being earned,
payments made in discharge of that obligation are payments made out
of the profits or gains of the Company, within the meaning
of [what is now ICTA88/S74 (l)].
In my opinion, for that proposition there is
no foundation at all in principle or on authority.
In the House of Lords, Lord Buckmaster found the case straightforward. He explained that the Revenue argument was based on the view that the rent was not a rent at all but something in the nature of a distribution of profits; that the landlords in effect shared in the profits on the same footing as the preference shareholders. But no one had challenged the bona fides of the rental agreements. The rent was covenanted to be paid as rent. Whether the whole sum was paid or only a part it was nevertheless rent of the trade premises and nothing but rent. He commented at pages 329 and 330 of 16TC:
My Lords, the first thing, and, to my mind,
the only thing, to be considered is this: Is this or is this not
rent payable under this lease? No attack whatever has been made
upon the document itself. It was said that there had been an
arrangement of property to try to avoid payment of Income Tax, of
which, it may be, the document is one of the instruments; but
nobody has challenged the bona fides of the document itself; nobody
has said that the £960,000 is a fictitious or an artificial
sum. It is admitted that this case has to be determined on the
hypothesis that this is a perfectly sound business document, and it
is upon that ground that the payment has been attacked.
When the matter is so considered, in spite of
the efforts of the Law Officers, I find myself quite unable to
understand what is the argument upon which this assessment is
supported. The rent is covenanted to be paid as rent. There is no
provision whatever in the lease that the condition precedent to the
payment of that rent is the earning of profits. It is not disputed
that at any time, up to the 31st December action could be taken at
law for payment of the quarterly sums. The only thing that is
provided is that if at the end of the year when the balance sheet
is made up certain payments cannot he made if the full rent is
charged, instead of the full rent being charged a smaller sum shall
be charged, and if anything has been overpaid it shall be returned.
But whether the whole sum or part of it is paid, the payment is the
rent of business premises and nothing but rent.
