BIM38400 - Wholly & exclusively: artificial prices
The excess over the commercial price is not for the purposes of the trade
Where an inflated, or otherwise artificial price, is apparently paid for trading stock there is usually some other purpose involved. Lord Cross gives a good example at page 100 in the linked cases of Ransom v Higgs and Kilmorie (Aldridge) Ltd v Dickinson [1974] 50TC1. Lord Cross talks about a retailer buying stock from a relative at more than the commercial price in order to help the relative get started in business.
The case itself concerns another such example. Where, as part of a scheme for tax avoidance, a sum in excess of the commercial price is paid, there is a presumption that the excess is not expended for the purposes of the trade. Roskill L J explaining at page 56 of 50TC that the payment made by Kilmorie was not made in order to increase the company’s profits but rather to try to reduce them so that they appeared in a non-taxable form in someone else's hands.
Ransom v Higgs concerned an avoidance scheme designed to develop properties but secure that any profits did not attract IT rather they were to be capital receipts of certain trusts. The events took place before the introduction of CGT in 1965.
Lord Reid explains that whilst the Revenue cannot second guess the quantum of payment made where there are sound commercial reasons in a case of tax avoidance the claimed deduction will not be wholly and exclusively for the purposes of the trade. The judge mentioned the possibility that a finding of duality of purpose could lead to disallowance of the whole of the expenditure, including that which was for a trade purpose. But in this case the Revenue agreed to allow the market value (which was less than the sum paid).
For those who do not have ready access to tax case volumes, the part of Lord Reid and Lord Wiberforce’s judgements on which the above guidance is based is set out below:
The Special Commissioners decided against Kilmorie. They held that their agreement with Opendy
There was considerable argument about the meaning of this finding. I think that it plainly means that Kilmorie would not have paid so large a sum to Opendy but for their non-trading purpose of enabling the tax avoidance scheme to succeed. Neither party to the agreement was acting as a free agent in its own interest. Opendy was a Harlox subsidiary and Kilmorie was a Downes company. Both had been procured to play their part in the scheme. The price was dictated by the scheme, and plainly had nothing to do with the market value of the rights sold. It was argued that we must presume that the directors, or whoever made the agreement on behalf of the two companies, acted properly in what they believed to be the interests of the companies. In the ordinary course we would presume that in the absence of evidence to the contrary. But here it is quite obvious that neither the Downes nor the Harlox companies acted in their own interests. They did just what Mr. Downes and Harlox wanted. I would agree that if a trader is actuated by none but commercial motives the Revenue cannot merely say that he has paid too much. He may have been foolish or he may have had what could fairly be regarded as a good commercial reason for paying too much. But if it is proved that some non-commercial reason caused the trader to pay more than he otherwise would have done, then it seems to me quite clear that the payment can no longer be held to have been wholly and exclusively expended for the purposes of the trade. No authority is needed for so obvious a proposition.
But what happens if even without the non-trading purpose the trader would have spent part of the sum for the purposes of his trade? On one view [what is now ICTA88/S74 (1)(a)] is so unreasonable that it forbids deduction even of that part which would in any case have been expended for trading purposes. It seems to me that the section could well be read as meaning that, if it can be shewn that a part of the expenditure was in fact wholly and exclusively for trading purposes, then that part is a proper deduction. But we do not have to decide that question, because the Revenue have agreed that in this case £2,250 of the £77,250 paid will be allowed as a deduction, being the then market value of the rights.
In the Kilmorie case I am of opinion that the decision of the Court of Appeal was clearly right; so I would dismiss the appeal.
Lord Wilberforce concurs in the following terms:
These profits were arrived at after deducting the premiums of £77,250 due to Opendy. Of these premiums £19,240 were paid in the year ended 31st March 1964. The question in this appeal is whether the deduction of this sum in computing Kilmorie's trading profits was justified. In order to be so, the deduction must satisfy the requirements of …[what is now ICTA88/S74 (1)(a)]
…My Lords, I so entirely agree with the reasoning [of the Special Commissioners], as to this matter, of Roskill L.J. that I can deal with this matter shortly: anything more would merely repeat his reasoning, on which I cannot improve. Counsel for the taxpayer, in an attractive argument, naturally placed much emphasis on the words ‘an essential prerequisite to the carrying out by Kilmorie of the development of the estate’. This, he said, amounted to a finding that the payment of the £77,250 (£19,240 in the relevant year) had to be made in order to secure the trading stock out of which the profits were made. If this is so it is not for the Courts to examine or even to consider whether the consideration was excessive: how a trader conducts a trade is his business, and it is no concern of the taxing authorities to see whether he could have made more profits than he did. In my opinion, the Commissioners' phrase will not bear the weight sought to be put on it and fails to lay the necessary foundation for the legal proposition which is said to follow from it. What the Commissioners meant by ‘an essential prerequisite’ is clear in this context: that is that the agreement with Opendy was a necessary step in the scheme which started with the acquisition of the building agreement and ended with the development by Kilmorie/Downes. The scheme required - almost as its linchpin - an agreement by which the prospective profits to be made by Kilmorie/Downes should be passed back through Opendy, so as to reach, as to £60,000, the trustees. The agreement was an essential prerequisite in this sense only: and what is not being said is that it was necessary in a commercial sense. The contrary to that is clearly found in the latter part of the paragraph. Once, then, these words are properly understood, the Commissioners' finding is fatal to the taxpayer's claim. To have found that to agree to pay £77,250 for the benefit of an agreement which barely a week earlier had been assigned for £2,250 was a commercial purpose would have been simply perverse. After all, the directors of A. J. Downes & Sons Ltd. had considered that on 30th March 1962 £2,250 was a good price fully reflecting the value of the building agreement. The price Kilmorie paid was 34 times that good price.
Adopting, as I do, the argument more fully developed by Roskill L.J., am of opinion that the Commissioners were right to disallow the deduction. I would dismiss this appeal.
