BIM37830 - Wholly & exclusively: expense of earning or application of profits?: technical assistance in return for a share of profits
An expense computed by reference to profits is not necessarily a distribution out of profits
Normally you should not disallow a payment simply because it is
measured by profits. The method of quantification does not fix the
character of the payment. You need to get to the bottom of the
arrangements so as to ensure that you do not confuse form and
substance. What may appear on a superficial examination to be a
distribution of profit may well be a genuine expense - for example,
a performance related fee. The reverse may be equally true.
In the case of British Sugar Manufacturers Ltd v Harris
[1937] 21TC528, the company entered into an agreement with the
Skoda Works in Czechoslovakia to pay for technical advice on the
use and operation of the plant required to process sugar beet.
British Sugar also entered into an agreement with British &
Allied Investments Corporation Ltd (Skoda’s UK financial
agents) for office accommodation and staff and general financial
advice. The payment to the two companies was to be 20% of the net
profit before depreciation; Skoda and their agent were to apportion
the sum between them by agreement.
The Special Commissioners decided that the payment was a
distribution of profits and so not an allowable deduction.
The High Court, with some reluctance, agreed.
In the Court of Appeal the Master of the Rolls, Sir Wilfred
Greene, explained that the method of computing the payment to Skoda
did not convert what was a trading expense into a share of profit.
The payment was therefore allowable. The Master of the Rolls
explained that there is difference between:
- a contract that simply provides for payment of a share of profits, and
- a payment of remuneration that was calculated by reference to profits and is deductible for tax purposes.
The distinction in some cases may be very difficult to draw. In
this particular case, the payment was a deductible expense and not
a share of profits. To make the distinction it is essential that
you fully of establish and understand the underlying facts.
For those who do not have ready access to tax case volumes,
the part of Sir Wilfred Greene’s judgement on which the above
guidance is based is set out below, 21TC from middle page 545 to
end page 546:
Now the matters to be observed in this case, I
think, are, first of all, the nature of the work that is being
done. The nature of the work that is being done is what one may
succinctly describe as ordinary management work or ordinary
advisory work in respect of technical matters. The next point to
observe is that what is referred to as ‘net profits’ is
a figure to be arrived at upon a conventional basis, not the basis
upon which the Company would ascertain its profits for commercial
purposes nor the basis upon which it would ascertain its profits
for Income Tax purposes, although, speaking for myself, I think
that the latter consideration is not one of any importance. But it
is an important factor to be considered (although I agree not
necessarily in any individual case conclusive) that the fund of so
called ‘profits’, to 20 per cent of which the companies
are to be entitled for their services, is a fund ascertained by
means of a conventional account between the parties.
Now, bearing all those things in mind, the
question arises: on which side of the line does the case fall? I
quite accept the proposition that there is a line between a
contract for payment of a share of profits simpliciter and a
payment of remuneration which is deductible in truth before the
profits divisible are ascertained, and that line in some cases may
be very difficult to draw…
Now in the present case there is nothing
approaching a purchase of a share of profits in that sense. It is
not cash that passes in exchange for these profits; it is services,
and the badge of such a contract is remuneration for services, and,
therefore, the first thing that this remuneration would certainly
not be is a share of profits purchased by the employee. Again I
quite accept the proposition that the mere circumstance by itself
that services are rendered may not be conclusive. I can conceive of
a case where a person contributes services to some sort of joint
adventure, while others contribute perhaps capital, land, plant and
goods, arranging between themselves (it may be something short of a
partnership) that nobody shall get anything until the pool of
profits is ascertained, and then they shall divide it up between
them in specified proportions. That, it seems to me, would be a
real agreement for division of profits, because there would be one
profit fund only. There would not be two ‘profit’ funds
to be ascertained for different purposes. There would be one profit
fund, and nobody would have any interest in anything until that
profit fund was ascertained and fell to be divided, but, in the
present case, that is not the fact. In the present case there are
two funds of so-called ‘profits’ which come into the
picture. The first one is the fund which has to be ascertained for
the purpose of calculating the 20 per cent In that fund as such,
the persons entitled to the profits of this Company, namely, the
shareholders, have no concern. It is used for the purpose, and for
the purpose only, of ascertaining what is to be paid to the Skoda
Works and to the Corporation. Now when that amount has been
ascertained, that fund has ceased to have any usefulness at all,
and it then becomes necessary to ascertain what are the divisible
profits and, for that purpose, to take another account, and the
account that is taken then would be an account which not only would
bring in depreciation (or, as they did here, would bring out a
figure expressed to be subject to depreciation), but would also
take into account the sum that had been paid out to the Skoda Works
and the Corporation upon the taking of the first account. It seems
to me that the circumstance that those two accounts have to be made
out throws a very clear light upon the real nature of this
transaction, and, looking at the clause in question as a whole, it
seems to me clear beyond any reasonable doubt that the agreement is
merely an agreement under which, before ascertaining the divisible
profits of this Company at all, the Skoda Works and the Corporation
are to receive, upon a particular conventional basis, a commission
sum as remuneration for their services. When that has been said, it
appears to me that it brings the case within a very familiar
category.
