Southern Railway of Peru Ltd v Owen (Inspector of Taxes) [1956] UKHL 4

House of Lords

Between

Southern Railway of Peru LtdAppellant

Owen (Inspector of Taxes)Respondent

Before

Lord Oaksey

Lord Mac-Dermott

Lord Radcliffe

Lord Tucker

Date 21 June 1956

[1]Die Jovis, 21° Junii 1956 Parliamentary Archives, HL/PO/JU/4/3/1039 Earl Jowitt Lord Oaksey Lord Mac- Dermott Lord Radcliffe Lord Tucker HOUSE OF LORDS SOUTHERN RAILWAY OF PERU LIMITED v. OWEN (Inspector of Taxes) 21st June 1956 Earl Jowitt MY LORDS, I have had the advantage of reading the Opinion which is about to be delivered by my noble and learned friend Lord Radcliffe, with which I agree, and have nothing to add. Lord Oaksey MY LORDS, I agree that this appeal should be dismissed. Mr. Pennycuick, in his able argument for the Appellants, contended that the social legislation of Peru conferred upon the Appellants' employees a right to the compensation therein referred to in the year of taxation, and that as an employee could at any time give the requisite period of notice and claim the compensation at the expiration of that period the amount of compensation which would then be due was a sum which the Appellants were entitled to charge against the profits of the year although, in fact, the employee had given no such notice during the year. In my opinion, the fallacy of this argument lies in the fact that the employees whose com- pensation the Appellants sought to charge against their profits had not, as a matter of fact, given their notices or terminated their contracts, and it is clear, and not disputed, that no compensation was payable to them until their service was duly terminated. The Peruvian legislation contains certain provisions which entitle the Appellants to dismiss their employees for misconduct, and it is clear that until the contract of service is duly completed no liability to pay the compensation arises. Reliance was placed, during the argument, upon the Sun Insurance Office v. Clark , 6 TC 59 , in which this House held that a percentage of the premium income of an insurance company might be deferred as a receipt to a future year because it was paid as consideration for future liability, but the principle of that decision is not, in my opinion, applicable to the present case. The premium income was only deferred and would suffer tax in a future year, whereas in the present case if the Appellants are permitted to deduct com- pensation which they have not paid and which they may never have to pay that compensation will escape tax altogether. There is, in my opinion, a fundamental distinction between a contingent liability and a payment dependent upon a contingency. When a debt is not paid at the time it is incurred its payment is, of course, contingent upon the solvency of the debtor but the liability is not contingent. Similarly, the liability in the Sun Insurance case was not, in my opinion, contingent but remained in force throughout the period of the insurance, though payment in pursuance of that liability might or might not have to be made. The circumstances in the present case may put an end to the liability altogether, but in the case of insurance for a period the circumstance of loss does not put an end to the liability but merely makes payment obligatory in pursuance of the liability. 2 After all, the only question in the present case is whether the compensation should be deducted when it is in fact paid or should be deducted before it is paid and in circumstances in which it may never be paid. In my opinion, the reasoning and the judgments in the Court of Appeal are correct and should be affirmed. Lord MacDermott MY LORDS, In this appeal the Appellant claims that, in the computation of its profits for each of the years of assessment under review, an allowance should be made in respect of its liability to pay to the employees then in its service in Peru certain lump sums which, under Peruvian legislation, those employees will be entitled to receive from the Appellant on the due completion of their service. The appeal is therefore concerned with payments to be made after— and it may be long after—each of the relevant accounting periods has ended. No question arises as to the deduction of wages and salaries currently paid for services rendered. What the Appellant contends is, in effect, that the total cost of those services each year included, in addition to current wages and salaries, a provision to meet the amount by which the services rendered that year have enhanced the lump sums that will eventually be payable under the Peruvian legislation. In short, the Appellant maintains that its employees earn each year a deferred as well as a present remuneration and that the former, no less than the latter, must be taken into account if the true yearly profits are to be ascertained for the purposes of taxation. My Lords, as a general proposition it is, I think, right to say that in computing his taxable profits for a particular year a trader who is under a definite obligation to pay his employees for their services in that year an immediate payment and also a future payment in some subsequent year, may properly deduct not only the immediate payment but the present value of the future payment provided such present value can be satisfactorily determined or fairly estimated. Apart from special circumstances, such a procedure, if practicable, is justified because it brings the true costs of trading in the particular year into account for that year and thus promotes the ascertainment of the " annual profits or gains arising or accruing from " the trade. As I read the judgments, the substance of this proposition was accepted in the Court of Appeal; and before your Lordships the Crown, without making any formal concession, was not concerned to argue strenuously against it. The Crown's contention—and the view taken in the courts below—was rather to the effect that the proposition did not apply to the Appellant's case because(1) the Appellant was not under a definite obligation in any relevant year to pay its employees lump sums at the end of their engagements since, in each individual instance, the right to receive a lump sum depended upon the fulfilment of certain conditions that made the Appellant's prospective liability contingent until the service was duly terminated ; and

(2) it was impossible, in the circumstances, to regard any part of the lump sums as earned in or payable in respect of any particular year of service. The first of these arguments necessitates a reference to the effect of the relevant Peruvian legislation. This was summarised in the Court of Appeal by Jenkins L.J. in two paragraphs which were accepted by both parties and which read as follows: — "1. ' In the event of,' that is,' upon ' the determination of any service " contract between the Company and any employee, whether from the " employee's death, expiry of the term, or notice of determination given " on either side, the Company is liable to pay compensation calculated " as later appears to the employee or his representatives. 3 ''2. The above general proposition is subject to exception:: (A) in " the case of fixed term contracts where the contract has been determined " by the employee before expiry of the term otherwise than on account " of infringement by the Company; and (B) in the case (apparently) of " all contracts of service where there has been wrongful conduct of " certain kinds by the employee, e.g., dishonesty or insubordination." The position, therefore, was that the Appellant's liability to pay a lump sum could only be avoided by some breach of contract or grave misconduct on the part of the employee concerned. It may be correct to call such a liability contingent, but I must say the contingency seems to me too remote to justify a prudent trader or, for that matter, a competent accountant, in ignoring the liability until the day for payment has arrived. Whether, if this appeal related to but one employee and one lump sum, the degree of the contingency would, nevertheless, be such as to preclude a present allowance in respect of the future liability is a question which, in my opinion, does not call for decision on the facts of this case. I do not forget that the Court of Appeal looked at this contingency argument from the point of view of the individual employee and may, therefore, be taken as of a different opinion. With respect, however, I think that that was the wrong approach or, perhaps more accurately, that it should have been taken a stage further. The question, as I see it, on this branch of the case, was not whether, in a given year, the Appellant's liability to pay this employee or that was contingent: it was whether the Appellant's liability to make some payment in respect of the lump sums accruing for the benefit of all its employees in that year was in any relevant sense contingent. If that is the right view, I think the Crown's contention on this point must fail. It is clear from the accounts that the Appellant's employees during the material years were numerous and the chances of all, or even a substantial proportion of them, acting so as to forfeit their lump sum rights seem to me to be much too distant and improbable to merit significance. Here, the case bears a close resemblance to the state of affairs with which this House had to deal in Sun Insurance Office v. Clark ,

(1912) AC 443

; 6 TC 59 . There the tax-payer, a fire insurance company, was held entitled, in determining its taxable profits, to deduct from its premium income for the year an allowance for unexpired risks on policies outstanding at the end of the year. Forty per cent, of the premium income was accepted as a fair and reasonable estimate of such risks and the deduction was allowed as a proper method of ascertaining the true gains for the year in which the premiums were paid. Liability on each outstanding policy was, of course, highly contingent. But that there would be a loss on the collective risk was a matter of commercial certainty. On the facts, the situation in this appeal appears to me to be essentially the same. However one may describe the Appellant's liability as respects the lump sum which may become payable to a single employee, its liability to make some payment at a future date on foot of the body of presently accruing lump sum rights cannot well be regarded as contingent within the world of ordinary business affairs. Whether this future liability can be quantified for the purposes of taxation is another matter; but in the degree of its certainty it is not, in my opinion, to be distinguished in any material respect from the future liability which was taken into account in the Sun Insurance Office case. It was said that that decision related only to insurance business and had no application to the facts of this appeal. I see no reason for confining the scope of the decision in this way. Its ratio is much wider than that, and is in my view applicable to cases producing the same sort of problem, whether they relate to contracts of insurance or not. The Crown's second submission raises a very different and, as it seems to me, a more difficult issue. It turns on the true nature of the lump sum payment made to an employee at the end of his service. If the correct view were that such payment should be regarded merely as a statutory bounty, as something independent of the length or value of the services rendered except for arithmetical purposes, I should, as at present advised, find it difficult to resist the Crown's claim that it could only be allowed for in the year of payment; on this hypothesis it would be a trading expense of 4 that year and not, I think, of any other year. It is, however, dear that such is not the nature of the payment in question. The Crown conceded that it was deferred remuneration, and that is what the Special Commissioners and the Court of Appeal have held it to be. As Jenkins, L.J. put it, " The right to this compensation is regarded as part of the remuneration for " the services rendered by the employee ". There can, I think, be no doubt that this accords with the tenor of the Peruvian legislation. Thus, Law No. 6871, having made provision for the calculation of the lump sum in Article 1 (as modified) " at the rate of one month's salary per yearly service " time " says in Article 2— " Payment, such as is referred to in the foregoing article, from the " legal viewpoint, represents a remuneration which the employer pays " for the work of his employee, whether the latter's engagement is for " an indefinite period or for a fixed time ..." And Law No. 9463, speaking in the same strain, adds— " The reduction in remuneration accepted by an employee shall not " impair in any way the rights acquired for services rendered ... as " Compensation should be calculated per years of service in accordance " with the remuneration received until the time of the reduction. " Following compensation will be calculated in accordance with the " reduced remuneration." The lump sum payment has, therefore, to be regarded as deferred remunera- tion in respect of the entire period of service. This at once puts an obstacle in the way of debiting the whole sum in the accounts for the last year of service, as the Crown contends should be done, since to do so would be to inflate the cost of the services rendered for that year beyond the actual figure and thus produce a corresponding error in the amount of the annual profits. This obstacle may not conclude the matter and the error it induces may have to be accepted if no better way of computing the true profits is open. But before that can be conceded a negative answer must be found to one or other of two questions. The first of these, which is that raised by the submission under consideration, comes to this—can the amount of a lump sum payment properly be regarded as made up of parcels each of which is attributable to a particular year of service? And the second question is whether, if the lump sum can be allocated in that manner, a fair estimate can be made for each year of the provision required to meet the prospective liability. My Lords, the first of these questions would present little difficulty if each lump sum was simply the amount found by adding together a twelfth part of the remuneration actually paid in each year of service. In that event the method of computation, coupled with the circumstance that the lump sum is to be regarded as deferred remuneration, would seem to relate the payment to each year of service almost automatically. But that is not the scheme of the Peruvian legislation, the effect of which, in this connection, is thus summarised by Jenkins L.J.: — " The compensation is an amount equivalent to one month's salary or " one-twelfth of a year's salary at the rate in force at the date of deter- " mination for every year of service, provided that the right to compensa- " tion accrued up to any point of time is not liable to be diminished " in amount by subsequent reduction in pay." This provision undoubtedly leads to anomalies if one is to regard each year's accretion to a lump sum as remuneration earned in that year, the possible effect of an increase of remuneration (to take what is perhaps the most glaring example) being to raise the increment for the year of increase above that of subsequent as well as previous years. It is, f think, true to say that this consideration led Upjohn J. and, in the Court of Appeal, Jenkins L. J. to hold against the Appellant on this aspect of the matter. But, while I find the point far from easy, I am of opinion that the anomalies referred to have been given more than their due weight and that the true view is that the yearly Increments by which a lump sum is built up ought to be reckoned 5 for present purposes as remuneration in respect of the years in which they accrue. It must be remembered that the anomalies are the result of a statutory scheme and that the criterion of what is sensible or reasonable contractually does not arise. Moreover, if, as I think, the lump sum is to be regarded as deferred remuneration in respect of the entire service the case for relating each incremental step to the remuneration for the year in which it occurs cannot be lightly disregarded. After all, and whatever may be said of the manner in which the increments may fluctuate in amount, the scheme is such that at the end of each year an employee can tell with certainty not only what his lump sum will be if he then retires and does not forfeit his rights, but also how much each year of previous service has added to his entitlement. And finally, the language of Law No. 9463 with its reference to "rights acquired for services rendered" in a context relating to a point during the service and not at its end, goes at any rate some way to show that the legislation regarded the lump sum as accruing throughout the service. For these reasons I consider that the Crown has failed in both the sub- missions discussed and, accordingly, I would hold that the Appellant was right in contending that in principle it was entitled to make a deduction each year in respect of its prospective lump sum liabilities, provided such deduction can be fairly estimated or otherwise satisfactorily assessed. There remains the question which this proviso raises and which I have already posed. The difficulty here is that the deduction sought by the Appellant throughout has been the aggregate of the yearly increments by which the value of the future lump sum payments has been increased. That, I think, must be wrong as, apart from any adjustment to be made on account of possible forfeitures, this deduction makes no attempt to reflect the present value of payments which may not have to be made for anything up to the span of a man's industrial life. If the position is that no fair estimate or satisfactory computation of the provision to be made as respects the Appellant's prospective liabilities can be arrived at, then that is an end of the matter and the appeal must be dismissed. I am not disposed, however, to assume that that is the position or that it is beyond the power of those skilled in such matters to produce a series of acceptable deductions for the years affected by these proceedings. I express no opinion as to whether or not this can be done. I do not know. But on the whole I feel the Appellant should have an opportunity of putting this question to the test. If one may judge from the terms of the Case Stated it was not debated before the Special Commissioners and it must, I think, have been obscured in the courts below by the other issues which were the subject of a vigorous controversy throughout and were decided, wrongly as I consider, against the Appellant. While I appreciate that your Lordships would be reluctant to take any step likely to start this litigation on a further round of the courts, the outstanding point is now so much a matter of fact that there is, I think, but little danger of this. For my part, therefore, I would favour a remit to the Special Commissioners to ascertain whether it is practicable to arrive at satisfactory deductions and, if so, to determine what they should be. Lord Radcliffe MY LORDS, The Appellant has been operating its railway in Peru under the obligations of a statutory scheme by virtue of which its employees, generally speaking, are entitled to receive from it a lump sum payment on retirement, death or other termination of service. In effect, entitlement does not depend on any prescribed length of service: on the other hand an employee can forfeit his right to payment by wrongful conduct such as dishonesty or insubordination or by failure to give due notice of retirement, which in many cases is only a short one. Employees on fixed term contracts must complete their term without breach, except in the case where the company itself is in default. 32221 A 3 6 In my opinion the solution of this case does not depend on any precise analysis of the Appellant's obligations under Peruvian law. In this I am at one with the Special Commissioners, who nave set out in the Case all that it is necessary to know on this point. It amounts, I think, to this. The payments that fall due are retirement benefits and no payment is exigible from the company until service has been terminated. The amount of benefit is arrived at by taking a prescribed proportion of the salary of the closing year and multiplying it by the number of years of service, but this calculation is subject to a not unimportant proviso to the effect that if an employee's rate of salary or wage is reduced during the course of his service the reduction " shall not impair in any way the rights acquired for services " rendered .... as Compensation should be calculated per years of service in " accordance with the remuneration received until the time of the reduction. " Following compensation will be calculated in accordance with the reduced " remuneration " (Law No. 9463). Thus, what is paid in the year of retire- ment is paid in respect of the whole period of service and is indeed declared to represent a " remuneration which the employer pays for the work of " his employee " (Law No. 6871). On the other hand, it is a single sum and I do not think that it can be said that any particular part of what is paid is in law the earning of any particular year. It might be plausible to say so in the case of a salary that never varied: but such a description cannot really be made to fit the case of the salary that increases from time to time during the period of service. Now the question is, how ought the effects of this statutory scheme to be reflected in the Appellant's accounts of the annual profits arising from its trade? One way, which is certainly the simplest one, is to let the payments made fall entirely as expenses of the year of payment and ignore any question of making provision for the maturing obligation during the years of service that precede it. This is what the company seems to have done up to the year ending 30th June, 1947. and it is the system which is, according to the Crown, the only one which the law of income tax permits. It has one con- siderable advantage: no element of estimate or valuation appears in the profit assessment and nothing is charged to profits except the actual cash outgoing. But, when this has been conceded, I think that there is the very serious disadvantage to be set against the cash basis that it affords a comparatively inefficient method of arriving at the true profits of any one year. The retirement benefit is not, obviously, paid to obtain the services given in the year of retirement. The incidence of retirement payments must be variable from year to year, and they may inordinately depress the profits of one year just as they may inordinately inflate the profits of another. It is true that the company carries on business from one year to another, but it is not charged on the average of its annual profits. Tax rates and allowances themselves vary and, apart from that, to charge tax on a profit unduly accelerated or unduly deferred is, in my opinion, no more respectable an achievement than to admit that the annual accounts of business do in some cases require the introduction of estimates or valuations if a true statement of profit is to be secured. Another method is that which the Appellant is seeking to establish with regard to its assessments for the four years 1947-50. I will say at once that what it aims at (I do not say, what it achieves) appears to me to be a more accurate assessment of true annual profit than that which could be provided by the other method. When I am told, then, that its adoption is banned by some established principle of law, to which your Lordships are bound to give effect, I feel that I must enquire closely what that principle of law is and upon what understanding of accountancy practice the principle is said to be based. For the overriding principle of law is still, I believe, as it was stated by Lord Haldane in Sun Insurance Office v. Clark 6 TC 59 at p. 78:

" It is plain that the question of what is or is not profit or gain " must primarily be one of fact and of fact to be ascertained by the tests " applied in ordinary business. Questions of law can only arise when " (as was not the case here) some express statutory direction applies and "excludes ordinary commercial practice, or where, by reason of its being " impracticable to ascertain the facts sufficiently, some presumption has to be 7 "invoked to fill the gap."

And our task is: not made any easier by the knowledge that, though the law with its system of precedents may sometimes seem to stand still (I hope that it does not), it is quite certain that the techniques and practices of commercial accountancy are very far from static. What the Appellant claims the right to do is to charge against each year's receipts the cost of making provision for the retirement payments that will ultimately be thrown upon it by virtue of the fact that it has had the benefit of its employees' services during that year. As a corollary it will not make any charge to cover the actual payments made in the year in respect of retirement benefits. Only by such a method, it is said, can it bring against the receipts of the year the true cost of the services that it has used to earn those receipts. Generally speaking, this must, I think, be true. For, whereas it is possible that any one of its many employees may forfeit his benefit and so never require a payment, the substantial facts of the situation are that when the company has paid every salary and wage that is due for current remuneration of the year it has not by any means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employ- ment. This is a long-term application of the practice by which provision for holidays with pay in the coming year is charged in part against the receipts of the previous year. It does not seem to me inconsistent with the theory on which the claim is based that in the year when an increase of salary takes place and the expectation of a larger ultimate payment materialises an adjustment has to be made to take care of what has thus become the under-provision of earlier years. I agree that it is arbitrary to describe such an adjustment as accruing in respect of that year's service: but on the other hand it is a provision which is required in that year to take account of the increased burden which the year's salary for the year's service has thrown upon the employer. Of course, the company's claim must be understood in the light of the fact that it is an employer dealing with the cost of services rendered to it, by which it itself has received monies, say fares and freights, which enter into the current year's receipts. Generally speaking, I suppose, its takings are cash or short-term credits. The considerations which apply to this situation are not necessarily valid in other fields of income or expenditure. But in this field I agree that provision for retirement payments is more likely to give an accurate reflection of the true cost of earning the year's receipts than merely charging against them the year's payments to employees who retire in the year. The Courts have not found it impossible hitherto to make considerable adjustments in the actual fall of receipts or payments in order to arrive at a truer statement of the profits of successive years. After all, that is why income and expenditure accounting is preferred to cash accounting for this purpose. As I understand the matter, the principle that justified the attribution of some- thing that was in fact received in one year to the profits of an earlier year, as in such cases as Isaac Ho/den & Sons, Ltd, Ltd. v. Commissioners of Inland Revenue 12 T.C. 768 and Commissioners of Inland Revenue v. Newcastle Breweries Ltd. 12 TC 927 , was just this, that the payment had been earned by services given in the earlier year and therefore a true statement of profit required that the year which had borne the burden of the cost should have appropriated to it the benefit of the receipt. The principle is clearly stated in the speech of Lord Simon in Commissioners of Inland Revenue v. Gardner Mountain & D'Ambrumenil Limited 29 TC 69 , and I take leave to quote his words (see p. 93):

" In calculating the taxable profit of a business on Income Tax " principles . . . services completely rendered or goods supplied, which are " not to be paid for till a subsequent year, cannot, generally speaking, be " dealt with by treating the taxpayer's outlay as pure loss in the year in which " it was incurred and bringing in the remuneration as pure profit in the " subsequent year in which it is paid, or is due to be paid. In making an " assessment to Income Tax under Schedule D the net result of the trans- " action, setting expenses on the one side and a figure for remuneration on " the other side, ought to appear (as it would appear in a proper system of " accountancy) in the same year's profit and loss account, and that year will 8 " be the year when the service was rendered or the goods delivered. . . . "

This may involve, in some instances, an estimate of what the future " remuneration will amount to (and, in theory, though not usually In practice, " a discounting of the amount to be paid in the future). ... If the accounts " ... were made up before the amount of the commission was ascertained, a " provisional estimate of what the amount would be might be inserted in the " first place and could be corrected when the precise figure was known, by " additional assessment or by a return of any excess within six years of the " original assessment." Lord Simon's principle is not stated in terms which fully cover the present case. For he speaks of " services completely rendered ". Moreover, the decisions I have mentioned were all cases of receipts the precise amount of which had been ascertained, though after the end of the year to which they properly belonged. No doubt it is much easier to get a satisfactory method for dealing with such cases. In the present case the analogue would be to wait until each retiring payment was made and then to write it back in appropriate proportions over the years covering the whole period of service. But such a method, even if ideal, is not practical politics and we can. I think, put it out of our minds. There seems, therefore, to be no alternative between letting each payment fall upon the year in which it is made or adopting some scheme of current provision such as the Appellant contends for. It is clear, at any rate, from what I have quoted above that there is nothing improper in admitting valuations or estimates if by so doing a truer balance is arrived at between the receipts of a year and the cost of earning them or the expenses of a year and the fruits of incurring them. Such estimates were in fact directed by the Court of Appeal and by this House in John Cronk & Sons, Ltd. v. Harrison 20 TC 612 and again by this House in Absalom v. Talbot 26 TC 166 . See too the judgment of Lord Greene, M.R. in Johnson v. W.S. & Try, Limited 27 T.C. 167 at p. 182. The decision in the last-mentioned case is, I think, of value in illustrating the point that, however desirable it may be to bring in a valuation or estimate in order to give a better balance to a year's accounts, it cannot be right to do so if the figure which is to be inserted, " hedged round . . . " with every kind of contingency and speculation ", is too uncertain to be fairly treated as a receipt. What is true of receipts is true of liabilities. In my opinion, it is that point which constitutes the real difficulty of the present case. But there is no difficulty if we accept the main argument of the Crown. That argument is that, quite simply, there is a rule of law which forbids the introduction of any provision for future payments in or payments out, if the right to receive them or the liability to make them is in legal terms contingent at the closing of the relevant year. The rule, it seems, is absolute and must be adhered to whatever the current principles or practices of commercial accountancy may require as a method of ascertaining the year's profits. And this is the argument which hitherto has prevailed in the High Court and the Court of Appeal. Now, in my opinion, there is no such rule of law governing the ascertainment of annual profits. Where does it come from? Not from anything to be found in the Income Tax Acts, which. indeed, by the well-known rule limiting the exclusion of debts, show a different and, as I think, a more realistic approach to the problem. Not from any decided authority which is binding on your Lordships. On the contrary, there are two decisions of this House which negative the existence of any such rule of law. In Sun Insurance Company v. Clark , supra , the House had to deal with the ascertainment of the profits of a fire insurance business which had two special features: it was growing, and the practice was in some cases to take premiums covering a longer risk than one year. The gross receipts inevitably included payments received in respect of unexpired policies, of each of which it could truly be said that any liability under it was contingent on the future maturing of the risk. No fire, nothing to pay. Yet the decision of the House recognised that it was correct for the insurance company to ascertain its profits for each year by carrying forward a fixed percentage of the gross premium income of the year as a provision 9 against unexpired risk. No doubt the carry-forward was treated as a receipt of the succeeding year and that year charged again with a new provision in respect of its new premiums. But the point is that the profit of each year was held to be correctly ascertained despite the inclusion of a provision for con- tingent liabilities. No doubt too this was insurance business. But insurance business does not live in a world of its own in income tax law. What it does is to throw up in an accentuated form some of the problems that affect, though perhaps in less degree, the ascertainment of the true profit of many other businesses. And in some cases special rules have to be evolved to deal with them. The other decision is Cronk v. Harrison, supra . The trader in that case had acquired by his trading a contingent right to receive certain monies deposited with a building society. It would be impossible to say of any one of these deposits in the year in which it was made that it represented a certain right for the trader to be paid any part of it in the future, for by the terms of the arrangement with the house purchaser default on his part might involve forfeiture or reduction of the trader's deposit. It was not money in the trader's hand, and, moreover, it might never be. Yet this House upheld the order of the Court of Appeal that the contingent rights ought to be brought in as receipts of the year in which they arose, though at a valuation (if feasible), not at their face value. I am satisfied by these decisions that there is no such rule of law as is suggested. The answer to the question what can or cannot be admitted into the annual account is not provided by any exact analysis of the legal form of the relevant obligation. In this case, as in the Sun Insurance case, you get into a world of unreality if you try to solve your problem in that way, because, where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision. For the trader the practical question is always the same in these cases—How much more shall I have to pay out or shall I be able to get in than my current accounts of the year are recording? Legal analysis of the obligation may present it in a variety of different forms. There is the deferred payment which is subject to nothing more than the practical contingency that it may not be received. That is dealt with, as we know, by bringing it in at its face value, subject to allowance, or, in some cases, at a valuation. There is the future payment for work done which is only legally exigible if the whole work is completed. A large part of this particular aspect must be covered by such items of receipt as work in progress, but I do not know enough of the methods of valuing or allowing for this to speak with any confidence about it. And, lastly, there is the contingent obligation to make a future payment, which is our present case. But, whatever the legal analysis, I think that for liabilities as for debts their proper treatment in annual statements of profit depends not upon the legal form but upon the trader's answers to two separate questions. The first is—Have I adequately stated my profits for the year if I do not include some figure in respect of these obligations? The second is—Do the circumstances of the case, which include the techniques of estab- lished accounting practice, make it possible to supply a figure reliable enough for the purpose? The authorities H. Ford & Co., Ltd. v. Commissioners of Inland Revenue 12 T.C. 997, Peter Merchant Ltd. v. Stedeford 30 T.C. 496. James Spencer & Co. v. Commissioners of Inland Revenue 32 T.C. 111, are no doubt very relevant in answering the second question, as must be the mere fact that an obligation is in its own terms contingent; but I regard them rather as illustrations of the kind of answer that should be given than as laying down any general principle or rule of law. Nor can I see what useful instruction is to be obtained from Lord Clyde's judgment in Whimster & Co. v. C.I.R . 12 T.C. 813. First, the learned judge's formulation of some general rules according to which annual profits should be determined for purposes of Income Tax is explicitly based on his understanding of what he calls "the correct principles of commercial 10 " accountancy ". Secondly, his observation, no doubt correct, that annual profits properly determined are not to be treated as reduced by the circum- stance that some part of them may be prudently reserved from distribution by the owner of the business to take care of an apprehended loss from future trading offers no solution to the problem of the present case, in which the accountants who have given evidence would say, I suppose, that they were not advocating the making of a reserve, but seeking to evaluate a current cost of working. This brings me at last to the facts of the present case. I am bound to say that, but for what has been found by the Special Commissioners, I should have thought that the charges for retirement benefits which the Appellant has claimed to make in the four relevant years were well on the wrong side of what was permissible. When account is taken of all the circumstances I should have thought that the sums charged were a very long way from affording a scientific appraisement of the additional burden arising in respect of the year's services; and were, therefore, in the nature of a rough reserve against the future rather than a measured provision. Because what the Appellant has done is simply this. It has calculated what sum would be required to be paid to each employee in respect of retirement benefit if he retired, without forfeiture, at the close of the year: and the aggregate of what is required is set aside in so far as the year has con- tributed to the aggregate. I think that that is a sufficiently accurate descrip- tion of the process as it was explained to us. But it seems to me to leave out of account several factors that are essential to the appraisement. First, there is the contingency itself that any one benefit may in the end be forfeited. This seems to me the least important of the factors, since it is extremely probable that most will be paid; and on the fact found that the Appellant had never yet failed to pay retirement benefit to an employee on any ground, I think that the weight of the contingency is in effect nothing. But, secondly, it must not be forgotten that these benefits and their scale are imposed by legislation, not by voluntary contract: and one cannot exclude the possibility that both the form and the scale of what has to be paid may be altered again without the company's consent. Thirdly, there is the very important factor of discount. To reserve each year's increment at face value, as the Appellant does, presents itself to me as making a serious over-provision. It is true that trade debts on short-term credit are not brought in at a discount; but here we are dealing with liabilities which cover a whole period of service and of which some may be deferred 30 or 40 years before payment. No doubt each is at call at the close of the year, in the sense that any employee may retire and claim his accrued benefits on notice. But the point is that most of the staff would not be doing that: and to provide each year's increment at face value on the ground that it is in that sense presently payable seems to me to be falling into the same error of confusing the individual legal form with the substance of the whole, which I find amiss with the argument for the Crown. In my opinion, therefore, the Appellant must be wrong in omitting to allow for discounting. So much, indeed, was conceded by its counsel in the course of argument. But then, it was said, that would be quite easy to do. I can see that it would be easy if the age of each workman and employee were known, the retirement age were fixed and each of them were to remain in service until that age. But then some will die and some will leave service before retiring age and these factors accelerate payment and so pro tanto increase the present value of each prospective payment. Well, it is said, given sufficient information, it will be possible to evaluate these factors by averages based on past experience and make adjustments of the discount accordingly. Perhaps it would, but the Case Stated gives us no information at all on the matter. And the averages themselves may be falsified by events, so leading either to over-provision or under-provision for the risks. If one is really going to formulate a water-tight scheme of providing for such a difficult problem, I should expect to find that it included an arrangement for periodical revision of the aggregate of the outstanding appropriations in the light of the current risks, so that anything over-provided could be brought back into taxation. 11 Bearing these consideration: in mind I find it impossible to give any con- clusive weight to the finding of the Special Commissioners that the Appellant': method of face value appropriations ought to be upheld, because " it was a " matter of correct accountancy practice in England to make provision in " the accounts for the sums m question in the circumstances of this case." I wish that I could, because I should view with dismay the assertion of legal theories as to the ascertainment of true annual profits which were in conflict with current accountancy practice and were not required by some special statutory provision of the Income Tax Acts. And it is apparent that in this case the Special Commissioners' finding was arrived at after hearing the evidence of the company's auditor and another independent accountant of distinction. The auditor said, as auditors have said before in other cases, that he " would not have signed the balance sheet without a qualification, " unless the afore-mentioned provision had been made." All this is very important, because, of course, accountants are very specially concerned with the problems that attend the true ascertainment of a year's profit and the establishment of techniques that assist in this. But, for all that, there is nothing in the Case that seems to me to fix on the point that is really the heart of this appeal. The requirements that an auditor may make before signing a balance sheet (I assume that the words used in the Case are meant to cover the statutory reference to the profit and loss account) do, no doubt, cover his opinion that that account gives a " true and fair view " of the profit for the financial year: but I do not think that such requirements are necessarily the same thing as the auditor's opinion that some particular provision could not be omitted without compromising the true and fair view. It is not possible completely to equate the balance shown by a company's profit and loss account with the balance of profit arising from the trade for the year. The word " provision " is becoming a technical one in contradistinction to the word " reserve " owing to the definitions of the two terms supplied by the Companies Act 1948, Schedule VIII, Part IV, paragraph 27: but the word " provision " includes any amount written off or retained " for any known "liability of which the amount cannot be determined with substantial " accuracy ", and J think that one is bound to say that references to an auditor's duty under the Companies Act take us into a field that is not exactly the same as that in which the annual profits of trade should be ascertained for the purposes of income tax. There is nothing in the evidence or the Special Commissioners' finding which supplies an answer to what I regard as the vital question relevant to these cases—is the sum provided an essential charge against the receipts of the trade in order to enable a true profit from that source to be stated for the year in question? And, as I see it, such a question cannot be answered just by one man's opinion. It is important to know how far it is supported by accepted theory or established practice. In the absence of any light on all these points, I think that your Lordships are bound to use your own judgment, supported, indeed, as it is, by the admissions made by the Appellant's counsel during the course of the hearing and by the fact that an alternative, albiet a rough and ready, method is available which has, after all, been adopted in the past. My Lords, I feel bound to come to the conclusion that the appeal fails. I do not think that this is an occasion upon which the case should be remitted to the Special Commissioners to see whether a new and more satisfactory method of provision could be extracted from evidence. The Appellant has stood throughout on its claim that the provisions that were claimed before the Special Commissioners were those that it was entitled to make, though I gather that during the course of the various appeals it was admitted that it might be proper to discount. To send the case back, when it is not even certain that a proper method can be found, is really to start it all over again and would apparently involve the hearing of further evidence. That is to go beyond the function of a final appeal. Lord Tucker MY LORDS, I have had the advantage of reading in print the Opinion of my noble and learned friend. Lord Radcliffe. which has just been delivered. I agree with 12 him that there is no such absolute rule of law governing the ascertainment of annual profits as was contended for by the Crown in the present case, and that there is no ground for holding that the decision of this House in Sun Insurance Office v. Clark 6 TC 59 must be confined exclusively to insurance companies. I also agree, for the reasons which he has given, that the finding of the Special Commissioners that the appellant's method of account- ing is in accordance with "correct accountancy practice" cannot, in the circumstances of this case, be regarded as conclusive. I would accordingly dismiss the appeal. (32221) Wt8124—124 35Vol. 7/56 D.L/PA/19 I have had the advantage of reading the Opinion which is about to be delivered by my noble and learned friend Lord Radcliffe, with which I agree, and have nothing to add. Lord Oaksey MY LORDS, I agree that this appeal should be dismissed.

[2]Mr. Pennycuick, in his able argument for the Appellants, contended that the social legislation of Peru conferred upon the Appellants' employees a right to the compensation therein referred to in the year of taxation, and that as an employee could at any time give the requisite period of notice and claim the compensation at the expiration of that period the amount of compensation which would then be due was a sum which the Appellants were entitled to charge against the profits of the year although, in fact, the employee had given no such notice during the year. In my opinion, the fallacy of this argument lies in the fact that the employees whose com- pensation the Appellants sought to charge against their profits had not, as a matter of fact, given their notices or terminated their contracts, and it is clear, and not disputed, that no compensation was payable to them until their service was duly terminated.

[3]The Peruvian legislation contains certain provisions which entitle the Appellants to dismiss their employees for misconduct, and it is clear that until the contract of service is duly completed no liability to pay the compensation arises.

[4]Reliance was placed, during the argument, upon the Sun Insurance Office v. Clark , 6 TC 59 , in which this House held that a percentage of the premium income of an insurance company might be deferred as a receipt to a future year because it was paid as consideration for future liability, but the principle of that decision is not, in my opinion, applicable to the present case. The premium income was only deferred and would suffer tax in a future year, whereas in the present case if the Appellants are permitted to deduct com- pensation which they have not paid and which they may never have to pay that compensation will escape tax altogether. There is, in my opinion, a fundamental distinction between a contingent liability and a payment dependent upon a contingency. When a debt is not paid at the time it is incurred its payment is, of course, contingent upon the solvency of the debtor but the liability is not contingent. Similarly, the liability in the Sun Insurance case was not, in my opinion, contingent but remained in force throughout the period of the insurance, though payment in pursuance of that liability might or might not have to be made.

[6]The circumstances in the present case may put an end to the liability altogether, but in the case of insurance for a period the circumstance of loss does not put an end to the liability but merely makes payment obligatory in pursuance of the liability. 2 After all, the only question in the present case is whether the compensation should be deducted when it is in fact paid or should be deducted before it is paid and in circumstances in which it may never be paid. In my opinion, the reasoning and the judgments in the Court of Appeal are correct and should be affirmed. Lord MacDermott MY LORDS,

[7]In this appeal the Appellant claims that, in the computation of its profits for each of the years of assessment under review, an allowance should be made in respect of its liability to pay to the employees then in its service in Peru certain lump sums which, under Peruvian legislation, those employees will be entitled to receive from the Appellant on the due completion of their service. The appeal is therefore concerned with payments to be made after— and it may be long after—each of the relevant accounting periods has ended. No question arises as to the deduction of wages and salaries currently paid for services rendered. What the Appellant contends is, in effect, that the total cost of those services each year included, in addition to current wages and salaries, a provision to meet the amount by which the services rendered that year have enhanced the lump sums that will eventually be payable under the Peruvian legislation. In short, the Appellant maintains that its employees earn each year a deferred as well as a present remuneration and that the former, no less than the latter, must be taken into account if the true yearly profits are to be ascertained for the purposes of taxation.

[8]My Lords,

[8]as a general proposition it is, I think, right to say that in computing his taxable profits for a particular year a trader who is under a definite obligation to pay his employees for their services in that year an immediate payment and also a future payment in some subsequent year, may properly deduct not only the immediate payment but the present value of the future payment provided such present value can be satisfactorily determined or fairly estimated. Apart from special circumstances, such a procedure, if practicable, is justified because it brings the true costs of trading in the particular year into account for that year and thus promotes the ascertainment of the " annual profits or gains arising or accruing from " the trade. As I read the judgments, the substance of this proposition was accepted in the Court of Appeal; and before your Lordships the Crown, without making any formal concession, was not concerned to argue strenuously against it. The Crown's contention—and the view taken in the courts below—was rather to the effect that the proposition did not apply to the Appellant's case because(1) the Appellant was not under a definite obligation in any relevant year to pay its employees lump sums at the end of their engagements since, in each individual instance, the right to receive a lump sum depended upon the fulfilment of certain conditions that made the Appellant's prospective liability contingent until the service was duly terminated ; and

(2) it was impossible, in the circumstances, to regard any part of the lump sums as earned in or payable in respect of any particular year of service.

[9]The first of these arguments necessitates a reference to the effect of the relevant Peruvian legislation. This was summarised in the Court of Appeal by Jenkins L.J. in two paragraphs which were accepted by both parties and which read as follows: — "1. ' In the event of,' that is,' upon ' the determination of any service " contract between the Company and any employee, whether from the " employee's death, expiry of the term, or notice of determination given " on either side, the Company is liable to pay compensation calculated " as later appears to the employee or his representatives. 3 ''2. The above general proposition is subject to exception::(a) (A) in " the case of fixed term contracts where the contract has been determined " by the employee before expiry of the term otherwise than on account " of infringement by the Company; and

(b) (B) in the case (apparently) of " all contracts of service where there has been wrongful conduct of " certain kinds by the employee, e.g., dishonesty or insubordination."

[10]The position, therefore, was that the Appellant's liability to pay a lump sum could only be avoided by some breach of contract or grave misconduct on the part of the employee concerned. It may be correct to call such a liability contingent, but I must say the contingency seems to me too remote to justify a prudent trader or, for that matter, a competent accountant, in ignoring the liability until the day for payment has arrived. Whether, if this appeal related to but one employee and one lump sum, the degree of the contingency would, nevertheless, be such as to preclude a present allowance in respect of the future liability is a question which, in my opinion, does not call for decision on the facts of this case. I do not forget that the Court of Appeal looked at this contingency argument from the point of view of the individual employee and may, therefore, be taken as of a different opinion. With respect, however, I think that that was the wrong approach or, perhaps more accurately, that it should have been taken a stage further. The question, as I see it, on this branch of the case, was not whether, in a given year, the Appellant's liability to pay this employee or that was contingent: it was whether the Appellant's liability to make some payment in respect of the lump sums accruing for the benefit of all its employees in that year was in any relevant sense contingent. If that is the right view, I think the Crown's contention on this point must fail. It is clear from the accounts that the Appellant's employees during the material years were numerous and the chances of all, or even a substantial proportion of them, acting so as to forfeit their lump sum rights seem to me to be much too distant and improbable to merit significance. Here, the case bears a close resemblance to the state of affairs with which this House had to deal in Sun Insurance Office v. Clark ,

(1912) AC 443

[12]The Crown's second submission raises a very different and, as it seems to me, a more difficult issue. It turns on the true nature of the lump sum payment made to an employee at the end of his service. If the correct view were that such payment should be regarded merely as a statutory bounty, as something independent of the length or value of the services rendered except for arithmetical purposes, I should, as at present advised, find it difficult to resist the Crown's claim that it could only be allowed for in the year of payment; on this hypothesis it would be a trading expense of 4 that year and not, I think, of any other year. It is, however, dear that such is not the nature of the payment in question. The Crown conceded that it was deferred remuneration, and that is what the Special Commissioners and the Court of Appeal have held it to be. As Jenkins, L.J. put it, " The right to this compensation is regarded as part of the remuneration for " the services rendered by the employee ". There can, I think, be no doubt that this accords with the tenor of the Peruvian legislation. Thus, Law No. 6871, having made provision for the calculation of the lump sum in Article 1 (as modified) " at the rate of one month's salary per yearly service " time " says in Article 2— " Payment, such as is referred to in the foregoing article, from the " legal viewpoint, represents a remuneration which the employer pays " for the work of his employee, whether the latter's engagement is for " an indefinite period or for a fixed time ..." And Law No. 9463, speaking in the same strain, adds— " The reduction in remuneration accepted by an employee shall not " impair in any way the rights acquired for services rendered ... as " Compensation should be calculated per years of service in accordance " with the remuneration received until the time of the reduction. " Following compensation will be calculated in accordance with the " reduced remuneration."

[13]The lump sum payment has, therefore, to be regarded as deferred remunera- tion in respect of the entire period of service. This at once puts an obstacle in the way of debiting the whole sum in the accounts for the last year of service, as the Crown contends should be done, since to do so would be to inflate the cost of the services rendered for that year beyond the actual figure and thus produce a corresponding error in the amount of the annual profits. This obstacle may not conclude the matter and the error it induces may have to be accepted if no better way of computing the true profits is open. But before that can be conceded a negative answer must be found to one or other of two questions. The first of these, which is that raised by the submission under consideration, comes to this—can the amount of a lump sum payment properly be regarded as made up of parcels each of which is attributable to a particular year of service? And the second question is whether, if the lump sum can be allocated in that manner, a fair estimate can be made for each year of the provision required to meet the prospective liability.

[14]My Lords,

[14]the first of these questions would present little difficulty if each lump sum was simply the amount found by adding together a twelfth part of the remuneration actually paid in each year of service. In that event the method of computation, coupled with the circumstance that the lump sum is to be regarded as deferred remuneration, would seem to relate the payment to each year of service almost automatically. But that is not the scheme of the Peruvian legislation, the effect of which, in this connection, is thus summarised by Jenkins L.J.: — " The compensation is an amount equivalent to one month's salary or " one-twelfth of a year's salary at the rate in force at the date of deter- " mination for every year of service, provided that the right to compensa- " tion accrued up to any point of time is not liable to be diminished " in amount by subsequent reduction in pay."

[15]This provision undoubtedly leads to anomalies if one is to regard each year's accretion to a lump sum as remuneration earned in that year, the possible effect of an increase of remuneration (to take what is perhaps the most glaring example) being to raise the increment for the year of increase above that of subsequent as well as previous years. It is, f think, true to say that this consideration led Upjohn J. and, in the Court of Appeal, Jenkins L. J. to hold against the Appellant on this aspect of the matter. But, while I find the point far from easy, I am of opinion that the anomalies referred to have been given more than their due weight and that the true view is that the yearly Increments by which a lump sum is built up ought to be reckoned 5 for present purposes as remuneration in respect of the years in which they accrue. It must be remembered that the anomalies are the result of a statutory scheme and that the criterion of what is sensible or reasonable contractually does not arise. Moreover, if, as I think, the lump sum is to be regarded as deferred remuneration in respect of the entire service the case for relating each incremental step to the remuneration for the year in which it occurs cannot be lightly disregarded. After all, and whatever may be said of the manner in which the increments may fluctuate in amount, the scheme is such that at the end of each year an employee can tell with certainty not only what his lump sum will be if he then retires and does not forfeit his rights, but also how much each year of previous service has added to his entitlement. And finally, the language of Law No. 9463 with its reference to "rights acquired for services rendered" in a context relating to a point during the service and not at its end, goes at any rate some way to show that the legislation regarded the lump sum as accruing throughout the service.

[16]For these reasons I consider that the Crown has failed in both the sub- missions discussed and, accordingly, I would hold that the Appellant was right in contending that in principle it was entitled to make a deduction each year in respect of its prospective lump sum liabilities, provided such deduction can be fairly estimated or otherwise satisfactorily assessed.

[17]There remains the question which this proviso raises and which I have already posed. The difficulty here is that the deduction sought by the Appellant throughout has been the aggregate of the yearly increments by which the value of the future lump sum payments has been increased. That, I think, must be wrong as, apart from any adjustment to be made on account of possible forfeitures, this deduction makes no attempt to reflect the present value of payments which may not have to be made for anything up to the span of a man's industrial life. If the position is that no fair estimate or satisfactory computation of the provision to be made as respects the Appellant's prospective liabilities can be arrived at, then that is an end of the matter and the appeal must be dismissed. I am not disposed, however, to assume that that is the position or that it is beyond the power of those skilled in such matters to produce a series of acceptable deductions for the years affected by these proceedings. I express no opinion as to whether or not this can be done. I do not know. But on the whole I feel the Appellant should have an opportunity of putting this question to the test. If one may judge from the terms of the Case Stated it was not debated before the Special Commissioners and it must, I think, have been obscured in the courts below by the other issues which were the subject of a vigorous controversy throughout and were decided, wrongly as I consider, against the Appellant. While I appreciate that your Lordships would be reluctant to take any step likely to start this litigation on a further round of the courts, the outstanding point is now so much a matter of fact that there is, I think, but little danger of this. For my part, therefore, I would favour a remit to the Special Commissioners to ascertain whether it is practicable to arrive at satisfactory deductions and, if so, to determine what they should be. Lord Radcliffe MY LORDS,

[18]The Appellant has been operating its railway in Peru under the obligations of a statutory scheme by virtue of which its employees, generally speaking, are entitled to receive from it a lump sum payment on retirement, death or other termination of service. In effect, entitlement does not depend on any prescribed length of service: on the other hand an employee can forfeit his right to payment by wrongful conduct such as dishonesty or insubordination or by failure to give due notice of retirement, which in many cases is only a short one. Employees on fixed term contracts must complete their term without breach, except in the case where the company itself is in default. 32221 A 3 6

[19]In my opinion the solution of this case does not depend on any precise analysis of the Appellant's obligations under Peruvian law. In this I am at one with the Special Commissioners, who nave set out in the Case all that it is necessary to know on this point. It amounts, I think, to this. The payments that fall due are retirement benefits and no payment is exigible from the company until service has been terminated. The amount of benefit is arrived at by taking a prescribed proportion of the salary of the closing year and multiplying it by the number of years of service, but this calculation is subject to a not unimportant proviso to the effect that if an employee's rate of salary or wage is reduced during the course of his service the reduction " shall not impair in any way the rights acquired for services " rendered .... as Compensation should be calculated per years of service in " accordance with the remuneration received until the time of the reduction. " Following compensation will be calculated in accordance with the reduced " remuneration " (Law No. 9463). Thus, what is paid in the year of retire- ment is paid in respect of the whole period of service and is indeed declared to represent a " remuneration which the employer pays for the work of " his employee " (Law No. 6871). On the other hand, it is a single sum and I do not think that it can be said that any particular part of what is paid is in law the earning of any particular year. It might be plausible to say so in the case of a salary that never varied: but such a description cannot really be made to fit the case of the salary that increases from time to time during the period of service.

[20]Now the question is, how ought the effects of this statutory scheme to be reflected in the Appellant's accounts of the annual profits arising from its trade? One way, which is certainly the simplest one, is to let the payments made fall entirely as expenses of the year of payment and ignore any question of making provision for the maturing obligation during the years of service that precede it. This is what the company seems to have done up to the year ending 30th June, 1947. and it is the system which is, according to the Crown, the only one which the law of income tax permits. It has one con- siderable advantage: no element of estimate or valuation appears in the profit assessment and nothing is charged to profits except the actual cash outgoing. But, when this has been conceded, I think that there is the very serious disadvantage to be set against the cash basis that it affords a comparatively inefficient method of arriving at the true profits of any one year. The retirement benefit is not, obviously, paid to obtain the services given in the year of retirement. The incidence of retirement payments must be variable from year to year, and they may inordinately depress the profits of one year just as they may inordinately inflate the profits of another. It is true that the company carries on business from one year to another, but it is not charged on the average of its annual profits. Tax rates and allowances themselves vary and, apart from that, to charge tax on a profit unduly accelerated or unduly deferred is, in my opinion, no more respectable an achievement than to admit that the annual accounts of business do in some cases require the introduction of estimates or valuations if a true statement of profit is to be secured.

[21]Another method is that which the Appellant is seeking to establish with regard to its assessments for the four years 1947-50. I will say at once that what it aims at (I do not say, what it achieves) appears to me to be a more accurate assessment of true annual profit than that which could be provided by the other method. When I am told, then, that its adoption is banned by some established principle of law, to which your Lordships are bound to give effect, I feel that I must enquire closely what that principle of law is and upon what understanding of accountancy practice the principle is said to be based. For the overriding principle of law is still, I believe, as it was stated by Lord Haldane in Sun Insurance Office v. Clark 6 TC 59 at p. 78:

" It is plain that the question of what is or is not profit or gain " must primarily be one of fact and of fact to be ascertained by the tests " applied in ordinary business. Questions of law can only arise when " (as was not the case here) some express statutory direction applies and "excludes ordinary commercial practice, or where, by reason of its being " impracticable to ascertain the facts sufficiently, some presumption has to be 7 "invoked to fill the gap."

[23]What the Appellant claims the right to do is to charge against each year's receipts the cost of making provision for the retirement payments that will ultimately be thrown upon it by virtue of the fact that it has had the benefit of its employees' services during that year. As a corollary it will not make any charge to cover the actual payments made in the year in respect of retirement benefits. Only by such a method, it is said, can it bring against the receipts of the year the true cost of the services that it has used to earn those receipts. Generally speaking, this must, I think, be true. For, whereas it is possible that any one of its many employees may forfeit his benefit and so never require a payment, the substantial facts of the situation are that when the company has paid every salary and wage that is due for current remuneration of the year it has not by any means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employ- ment. This is a long-term application of the practice by which provision for holidays with pay in the coming year is charged in part against the receipts of the previous year. It does not seem to me inconsistent with the theory on which the claim is based that in the year when an increase of salary takes place and the expectation of a larger ultimate payment materialises an adjustment has to be made to take care of what has thus become the under-provision of earlier years. I agree that it is arbitrary to describe such an adjustment as accruing in respect of that year's service: but on the other hand it is a provision which is required in that year to take account of the increased burden which the year's salary for the year's service has thrown upon the employer. Of course, the company's claim must be understood in the light of the fact that it is an employer dealing with the cost of services rendered to it, by which it itself has received monies, say fares and freights, which enter into the current year's receipts. Generally speaking, I suppose, its takings are cash or short-term credits. The considerations which apply to this situation are not necessarily valid in other fields of income or expenditure. But in this field I agree that provision for retirement payments is more likely to give an accurate reflection of the true cost of earning the year's receipts than merely charging against them the year's payments to employees who retire in the year.

[24]The Courts have not found it impossible hitherto to make considerable adjustments in the actual fall of receipts or payments in order to arrive at a truer statement of the profits of successive years. After all, that is why income and expenditure accounting is preferred to cash accounting for this purpose. As I understand the matter, the principle that justified the attribution of some- thing that was in fact received in one year to the profits of an earlier year, as in such cases as Isaac Ho/den & Sons, Ltd, Ltd. v. Commissioners of Inland Revenue 12 T.C. 768 and Commissioners of Inland Revenue v. Newcastle Breweries Ltd. 12 TC 927 , was just this, that the payment had been earned by services given in the earlier year and therefore a true statement of profit required that the year which had borne the burden of the cost should have appropriated to it the benefit of the receipt. The principle is clearly stated in the speech of Lord Simon in Commissioners of Inland Revenue v. Gardner Mountain & D'Ambrumenil Limited 29 TC 69 , and I take leave to quote his words (see p. 93):

" In calculating the taxable profit of a business on Income Tax " principles . . . services completely rendered or goods supplied, which are " not to be paid for till a subsequent year, cannot, generally speaking, be " dealt with by treating the taxpayer's outlay as pure loss in the year in which " it was incurred and bringing in the remuneration as pure profit in the " subsequent year in which it is paid, or is due to be paid. In making an " assessment to Income Tax under Schedule D the net result of the trans- " action, setting expenses on the one side and a figure for remuneration on " the other side, ought to appear (as it would appear in a proper system of " accountancy) in the same year's profit and loss account, and that year will 8 " be the year when the service was rendered or the goods delivered. . . . "

[26]Lord Simon's principle is not stated in terms which fully cover the present case. For he speaks of " services completely rendered ". Moreover, the decisions I have mentioned were all cases of receipts the precise amount of which had been ascertained, though after the end of the year to which they properly belonged. No doubt it is much easier to get a satisfactory method for dealing with such cases. In the present case the analogue would be to wait until each retiring payment was made and then to write it back in appropriate proportions over the years covering the whole period of service. But such a method, even if ideal, is not practical politics and we can. I think, put it out of our minds. There seems, therefore, to be no alternative between letting each payment fall upon the year in which it is made or adopting some scheme of current provision such as the Appellant contends for. It is clear, at any rate, from what I have quoted above that there is nothing improper in admitting valuations or estimates if by so doing a truer balance is arrived at between the receipts of a year and the cost of earning them or the expenses of a year and the fruits of incurring them. Such estimates were in fact directed by the Court of Appeal and by this House in John Cronk & Sons, Ltd. v. Harrison 20 TC 612 and again by this House in Absalom v. Talbot 26 TC 166 . See too the judgment of Lord Greene, M.R. in Johnson v. W.S. & Try, Limited 27 T.C. 167 at p. 182. The decision in the last-mentioned case is, I think, of value in illustrating the point that, however desirable it may be to bring in a valuation or estimate in order to give a better balance to a year's accounts, it cannot be right to do so if the figure which is to be inserted, " hedged round . . . " with every kind of contingency and speculation ", is too uncertain to be fairly treated as a receipt. What is true of receipts is true of liabilities. In my opinion, it is that point which constitutes the real difficulty of the present case. But there is no difficulty if we accept the main argument of the Crown. That argument is that, quite simply, there is a rule of law which forbids the introduction of any provision for future payments in or payments out, if the right to receive them or the liability to make them is in legal terms contingent at the closing of the relevant year. The rule, it seems, is absolute and must be adhered to whatever the current principles or practices of commercial accountancy may require as a method of ascertaining the year's profits. And this is the argument which hitherto has prevailed in the High Court and the Court of Appeal. Now, in my opinion, there is no such rule of law governing the ascertainment of annual profits. Where does it come from? Not from anything to be found in the Income Tax Acts, which. indeed, by the well-known rule limiting the exclusion of debts, show a different and, as I think, a more realistic approach to the problem. Not from any decided authority which is binding on your Lordships. On the contrary, there are two decisions of this House which negative the existence of any such rule of law. In Sun Insurance Company v. Clark , supra , the House had to deal with the ascertainment of the profits of a fire insurance business which had two special features: it was growing, and the practice was in some cases to take premiums covering a longer risk than one year. The gross receipts inevitably included payments received in respect of unexpired policies, of each of which it could truly be said that any liability under it was contingent on the future maturing of the risk. No fire, nothing to pay. Yet the decision of the House recognised that it was correct for the insurance company to ascertain its profits for each year by carrying forward a fixed percentage of the gross premium income of the year as a provision 9 against unexpired risk. No doubt the carry-forward was treated as a receipt of the succeeding year and that year charged again with a new provision in respect of its new premiums. But the point is that the profit of each year was held to be correctly ascertained despite the inclusion of a provision for con- tingent liabilities. No doubt too this was insurance business. But insurance business does not live in a world of its own in income tax law. What it does is to throw up in an accentuated form some of the problems that affect, though perhaps in less degree, the ascertainment of the true profit of many other businesses. And in some cases special rules have to be evolved to deal with them.

[27]The other decision is Cronk v. Harrison, supra . The trader in that case had acquired by his trading a contingent right to receive certain monies deposited with a building society. It would be impossible to say of any one of these deposits in the year in which it was made that it represented a certain right for the trader to be paid any part of it in the future, for by the terms of the arrangement with the house purchaser default on his part might involve forfeiture or reduction of the trader's deposit. It was not money in the trader's hand, and, moreover, it might never be. Yet this House upheld the order of the Court of Appeal that the contingent rights ought to be brought in as receipts of the year in which they arose, though at a valuation (if feasible), not at their face value. I am satisfied by these decisions that there is no such rule of law as is suggested. The answer to the question what can or cannot be admitted into the annual account is not provided by any exact analysis of the legal form of the relevant obligation. In this case, as in the Sun Insurance case, you get into a world of unreality if you try to solve your problem in that way, because, where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision. For the trader the practical question is always the same in these cases—How much more shall I have to pay out or shall I be able to get in than my current accounts of the year are recording? Legal analysis of the obligation may present it in a variety of different forms. There is the deferred payment which is subject to nothing more than the practical contingency that it may not be received. That is dealt with, as we know, by bringing it in at its face value, subject to allowance, or, in some cases, at a valuation. There is the future payment for work done which is only legally exigible if the whole work is completed. A large part of this particular aspect must be covered by such items of receipt as work in progress, but I do not know enough of the methods of valuing or allowing for this to speak with any confidence about it. And, lastly, there is the contingent obligation to make a future payment, which is our present case. But, whatever the legal analysis, I think that for liabilities as for debts their proper treatment in annual statements of profit depends not upon the legal form but upon the trader's answers to two separate questions. The first is—Have I adequately stated my profits for the year if I do not include some figure in respect of these obligations? The second is—Do the circumstances of the case, which include the techniques of estab- lished accounting practice, make it possible to supply a figure reliable enough for the purpose? The authorities H. Ford & Co., Ltd. v. Commissioners of Inland Revenue 12 T.C. 997, Peter Merchant Ltd. v. Stedeford 30 T.C. 496. James Spencer & Co. v. Commissioners of Inland Revenue 32 T.C. 111, are no doubt very relevant in answering the second question, as must be the mere fact that an obligation is in its own terms contingent; but I regard them rather as illustrations of the kind of answer that should be given than as laying down any general principle or rule of law.

[28]Nor can I see what useful instruction is to be obtained from Lord Clyde's judgment in Whimster & Co. v. C.I.R . 12 T.C. 813. First, the learned judge's formulation of some general rules according to which annual profits should be determined for purposes of Income Tax is explicitly based on his understanding of what he calls "the correct principles of commercial 10 " accountancy ". Secondly, his observation, no doubt correct, that annual profits properly determined are not to be treated as reduced by the circum- stance that some part of them may be prudently reserved from distribution by the owner of the business to take care of an apprehended loss from future trading offers no solution to the problem of the present case, in which the accountants who have given evidence would say, I suppose, that they were not advocating the making of a reserve, but seeking to evaluate a current cost of working.

[29]This brings me at last to the facts of the present case. I am bound to say that, but for what has been found by the Special Commissioners, I should have thought that the charges for retirement benefits which the Appellant has claimed to make in the four relevant years were well on the wrong side of what was permissible. When account is taken of all the circumstances I should have thought that the sums charged were a very long way from affording a scientific appraisement of the additional burden arising in respect of the year's services; and were, therefore, in the nature of a rough reserve against the future rather than a measured provision. Because what the Appellant has done is simply this. It has calculated what sum would be required to be paid to each employee in respect of retirement benefit if he retired, without forfeiture, at the close of the year: and the aggregate of what is required is set aside in so far as the year has con- tributed to the aggregate. I think that that is a sufficiently accurate descrip- tion of the process as it was explained to us. But it seems to me to leave out of account several factors that are essential to the appraisement.

[30]First, there is the contingency itself that any one benefit may in the end be forfeited. This seems to me the least important of the factors, since it is extremely probable that most will be paid; and on the fact found that the Appellant had never yet failed to pay retirement benefit to an employee on any ground, I think that the weight of the contingency is in effect nothing. But, secondly, it must not be forgotten that these benefits and their scale are imposed by legislation, not by voluntary contract: and one cannot exclude the possibility that both the form and the scale of what has to be paid may be altered again without the company's consent. Thirdly, there is the very important factor of discount. To reserve each year's increment at face value, as the Appellant does, presents itself to me as making a serious over-provision. It is true that trade debts on short-term credit are not brought in at a discount; but here we are dealing with liabilities which cover a whole period of service and of which some may be deferred 30 or 40 years before payment. No doubt each is at call at the close of the year, in the sense that any employee may retire and claim his accrued benefits on notice. But the point is that most of the staff would not be doing that: and to provide each year's increment at face value on the ground that it is in that sense presently payable seems to me to be falling into the same error of confusing the individual legal form with the substance of the whole, which I find amiss with the argument for the Crown.

[31]In my opinion, therefore, the Appellant must be wrong in omitting to allow for discounting. So much, indeed, was conceded by its counsel in the course of argument. But then, it was said, that would be quite easy to do. I can see that it would be easy if the age of each workman and employee were known, the retirement age were fixed and each of them were to remain in service until that age. But then some will die and some will leave service before retiring age and these factors accelerate payment and so pro tanto increase the present value of each prospective payment. Well, it is said, given sufficient information, it will be possible to evaluate these factors by averages based on past experience and make adjustments of the discount accordingly. Perhaps it would, but the Case Stated gives us no information at all on the matter. And the averages themselves may be falsified by events, so leading either to over-provision or under-provision for the risks. If one is really going to formulate a water-tight scheme of providing for such a difficult problem, I should expect to find that it included an arrangement for periodical revision of the aggregate of the outstanding appropriations in the light of the current risks, so that anything over-provided could be brought back into taxation. 11

[32]Bearing these consideration: in mind I find it impossible to give any con- clusive weight to the finding of the Special Commissioners that the Appellant': method of face value appropriations ought to be upheld, because " it was a " matter of correct accountancy practice in England to make provision in " the accounts for the sums m question in the circumstances of this case." I wish that I could, because I should view with dismay the assertion of legal theories as to the ascertainment of true annual profits which were in conflict with current accountancy practice and were not required by some special statutory provision of the Income Tax Acts. And it is apparent that in this case the Special Commissioners' finding was arrived at after hearing the evidence of the company's auditor and another independent accountant of distinction. The auditor said, as auditors have said before in other cases, that he " would not have signed the balance sheet without a qualification, " unless the afore-mentioned provision had been made."

[33]All this is very important, because, of course, accountants are very specially concerned with the problems that attend the true ascertainment of a year's profit and the establishment of techniques that assist in this. But, for all that, there is nothing in the Case that seems to me to fix on the point that is really the heart of this appeal. The requirements that an auditor may make before signing a balance sheet (I assume that the words used in the Case are meant to cover the statutory reference to the profit and loss account) do, no doubt, cover his opinion that that account gives a " true and fair view " of the profit for the financial year: but I do not think that such requirements are necessarily the same thing as the auditor's opinion that some particular provision could not be omitted without compromising the true and fair view. It is not possible completely to equate the balance shown by a company's profit and loss account with the balance of profit arising from the trade for the year. The word " provision " is becoming a technical one in contradistinction to the word " reserve " owing to the definitions of the two terms supplied by the Companies Act 1948, Schedule VIII, Part IV, paragraph 27: but the word " provision " includes any amount written off or retained " for any known "liability of which the amount cannot be determined with substantial " accuracy ", and J think that one is bound to say that references to an auditor's duty under the Companies Act take us into a field that is not exactly the same as that in which the annual profits of trade should be ascertained for the purposes of income tax. There is nothing in the evidence or the Special Commissioners' finding which supplies an answer to what I regard as the vital question relevant to these cases—is the sum provided an essential charge against the receipts of the trade in order to enable a true profit from that source to be stated for the year in question? And, as I see it, such a question cannot be answered just by one man's opinion. It is important to know how far it is supported by accepted theory or established practice. In the absence of any light on all these points, I think that your Lordships are bound to use your own judgment, supported, indeed, as it is, by the admissions made by the Appellant's counsel during the course of the hearing and by the fact that an alternative, albiet a rough and ready, method is available which has, after all, been adopted in the past.

[34]My Lords,

[34]I feel bound to come to the conclusion that the appeal fails. I do not think that this is an occasion upon which the case should be remitted to the Special Commissioners to see whether a new and more satisfactory method of provision could be extracted from evidence. The Appellant has stood throughout on its claim that the provisions that were claimed before the Special Commissioners were those that it was entitled to make, though I gather that during the course of the various appeals it was admitted that it might be proper to discount. To send the case back, when it is not even certain that a proper method can be found, is really to start it all over again and would apparently involve the hearing of further evidence. That is to go beyond the function of a final appeal. Lord Tucker MY LORDS, I have had the advantage of reading in print the Opinion of my noble and learned friend. Lord Radcliffe. which has just been delivered. I agree with 12

[35]him that there is no such absolute rule of law governing the ascertainment of annual profits as was contended for by the Crown in the present case, and that there is no ground for holding that the decision of this House in Sun Insurance Office v. Clark 6 TC 59 must be confined exclusively to insurance companies. I also agree, for the reasons which he has given, that the finding of the Special Commissioners that the appellant's method of account- ing is in accordance with "correct accountancy practice" cannot, in the circumstances of this case, be regarded as conclusive.

[36]I would accordingly dismiss the appeal. (32221) Wt8124—124 35Vol. 7/56 D.L/PA/19