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
‘... was an essential prerequisite to the carrying out by Kilmorie of the development of the estate. It proved, moreover, in the event to be very much to the advantage of Kilmorie to enter into the first-mentioned agreement (hereinafter referred to as 'the Kilmorie/Opendy agreement') on the terms specified therein. We have, however, to consider the position at the time when the Kilmorie/Opendy agreement was made, and against the background of the series of transactions which led up to it. So approaching the matter, we are of opinion that the Kilmorie/Opendy agreement was entered into by Kilmorie with the objects both of enabling that Company to develop the Landywood estate and of facilitating the scheme for avoiding liability to income tax referred to in para. 2(2) above. In our view the latter object was on the facts of the case one of the main purposes, and not a mere secondary consequence, of the entering into by Kilmorie of the agreement, and the outlay totalling £19,240 was thus incurred by Kilmorie for dual purposes, being purposes one of which was, and one of which was not, a trading purpose.’
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.
