Diamonds Limited v Commissioner of Income Tax (Civil Appeal No. 73 of 1954) [1955] EACA 292 (1 January 1955)

# COURT OF APPEAL FOR EASTERN AFRICA

Before SIR BARCLAY NIHILL (President), SIR NEWNHAM WORLEY (Vice-President) and BRIGGS, Justice of Appeal

# WILLIAMSON DIAMONDS LIMITED, Appellant (Original Appellant)

## THE COMMISSIONER OF INCOME TAX, Respondent (Original

### Respondent)

#### Civil Appeal No. 73 of 1954

(Appeal from the decision of H. M. High Court of Tanganyika, Mahon, J.) Income Tax—Appeal—Income Tax (Consolidation) Ordinance, 1950, section 21.

By section 21 (1) of the Income Tax (Consolidation) Ordinance, $1950$ :— "Where the Commissioner is satisfied that in respect of any period for which. the accounts of a company resident in the Territory have been made up, the profits distributed as dividends by that company up to the end of the sixth month after the last date upon which its accounts for that period are required by virtueof the provisions of the Companies Ordinance to be laid before the company in general meeting, increased by any tax payable thereon are less than 60 per cent of the total income of the company ascertained in accordance with the provisions of this Ordinance for that period, he may, unless he is satisfied that having regard to losses previously incurred by the company or to the smallness. of the profits made, the payment of a dividend or a larger dividend than that declared would be unreasonable, by notice in writing order that the undistributed. portion of 60 per cent of such total income of the company for that period shall be deemed to have been distributed as dividends amongst the shareholders as at the said last date and thereupon the proportionate share thereof of each shareholder shall be included in the total income of such shareholder for the purposeof this Ordinance: Provided that ....".

The respondent Commissioner made an order under section 21 aforesaid that a certain sum should be deemed to have been distributed to the shareholders. of B. M. Ltd. by way of dividend for the year ended 31st December, 1950.

On first appeal the Local Committee upheld the assessment.

On second appeal, the Supreme Court decided that as the balance sheet of the company did not show an overall deficiency in capital, it was unnecessary for the purpose of deciding the appeal, to construe the meaning of "losses" in the said section.

There was some doubt as to whether it is competent to appeal from an order made under the section.

Held (7-4-55).—(1) Semble--An appeal lies against an order made under section 21 aforesaid.. (2) The true effect of section 21 aforesaid is that the Commissioner must consider the company's position from a commercial point of view. He is not bound by the accounts put forward on behalf of a company, but he must consider them as a prudent man of<br>business would, and, if on the whole, he is of the opinion that, on that footing, the<br>company could not fairly be expected to pay a dividend under the section. This is so, even if no overall deficiency is established.

Appeal allowed. Matter remitted to the Commissioner of Income Tax with direction. that the existing order is a nullity leaving him to reconsider the whole matter and totake such steps as may be proper.

Cases referred to: Sir Kasturchand Ltd. v. C. I. T. Bombay (1949) 17 I. T. R. 493;<br>Montague Burton Ltd. v. C. I. R. 20 Tax Cases 48; C. I. R. v. Morrison 17 Tax Cases 325. Bechgaard and O'Donovan for appellant. Newbold, Q. C., for respondent.

BRIGGS, J. A.—The appellant is a shareholder in Buhemba Mines Limited, which I shall call "the company". On 25th April, 1952, the respondent Commissioner made an order under section 21 of the Income Tax (Consolidation) Ordinance, 1950, of Tanganyika that a sum of Sh. 457,920 should be deemed to have been distributed to the shareholders of the company by way of dividend in respect of the year ending 31st December, 1950. The appellant's share of this sum was Sh. 194,800/32 and income tax was assessed thereon at Sh. 9,740. The appellant contended that the order should not have been made and on this ground appealed against the assessment to the Local Committee and later to the High Court of Tanganyika, which both upheld the assessment. The appellant appeals again to this Court.

There seems to be some doubt whether it is competent to appeal against an order made under section 21, and it might be suggested that its propriety cannot in strict law be examined by means of an appeal against an assessment correctly based on the order; but this point was not taken for the respondent and I assume that an appeal of this kind will lie. It is certainly just and reasonable that the courts should be able to decide whether such an order was rightly made, and this method of raising the question is simple and convenient.

One of the grounds raised by the appellant was that part of the issued capital of the company consists of redeemable preference shares and that the payment of any dividend to the holders of founders' or ordinary shares before redemption of the outstanding preference shares would have been an invasion of the rights of the preference shareholders. No argument was addressed to the High Court or to us on this point, and the Articles of Association of the company were not included in the record before us. The point was not abandoned, but it has not been, and in the circumstances could not be, substantiated.

The first ground of appeal argued before us was that, although the company had made a profit in 1950, it had previously incurred capital losses and there was still an overall capital deficiency. It was contended that this fact made it either unlawful, or at least unreasonable and improper, to make an order under section 21. No oral evidence was led and the appellent relied entirely on the company's annual accounts for 1950, together with an admission to which I shall refer later. The balance sheet is in a form perfectly usual and proper for a mining company. Under "fixed assets at cost less depreciation, except where otherwise stated", it opens with "Development" under three heads "No. 1 Account", "No. 2 Account" and "Nigoti claims". The last is apparently of minor importance; the amount is only Sh. 5,000. No. 1 Account appears as follows: —

| | $Sh$ . | |----------------------------------------------------|---------------| | "As per last balance sheet | 1,762,402/95 | | Less: Amount written off 20<br>per<br>cent | | | <table><tbody>approximately</tbody></table> | 587,469/65 | | | | | Representing old development to be written | | | off<br>and the same state of the same state of the | 1.174.933/30" |

It might fairly be guessed, and in any event is agreed, that this refers to a mine -on the development of which some Sh. 2,900,000 had been spent, and which in or about 1948 was abandoned and decided to be worthless. It was expressly admitted that the item of Sh. 1,174,933/30 did not represent any reserves of workable ore. It seems that the company's' intention was to write off the whole of this development over the five years 1948-1952 inclusive—an entirely proper procedure. The No. 2 Development Account is in the following form:

| | | ъn. | |--------------------------------------------|------------------------------------|------------------------------------------| | "As per last balance sheet | . .<br>$\cdot$ | 393,401/67<br>$\cdot$ | | Additions during year<br>$\sim$ | $\cdot$ $\cdot$<br>$\cdot$ $\cdot$ | 368,485/24<br>$\sim$ | | Less: Redemption-33,052 tons at Sh. $7/26$ | | 761,886/91<br>239,957/52 | | Representing current development | $\cdot$ $\cdot$ | 521,929/39"<br>$\mathcal{L} \mathcal{L}$ | | | | |

This refers to the company's other mine, which was working and from which was derived in 1950 a net profit of over Sh. 1,000,000, as carried from the profit and loss account to the appropriation account. It may be noted that current depreciation, including "development redemption" or depletion on No. 2<br>Account, is charged in the profit and loss account, but "Redemption Development Account No. 1" is charged in the appropriation account. That account opens with a debit item of Sh. 509,856/35 brought forward from 1949, and closes with a reduced adverse balance of Sh. 40,662/88 carried forward to 1951. The balance sheet contains no property account and no reference whatever to land or rights over land except as described.

On this material the appellant invited the High Court, and invites us, to say that the company is suffering from an overall capital deficiency. I think we cannot possibly do so. The facts established seem to me to be these. The company has two mines of which one is worthless. A large sum spent on that worthless mine has been lost and is being written off. The other mine is working and producing profits. A large sum spent on developing it is rightly regarded as an asset; but no attempt has been made to show in the balance sheet or otherwise the value of the mine itself. We do not know whether the company has a freehold or other title. It may have a mere licence and there may be many good reasons which might induce a valuer to say that the value of the working mine is small. If the balance sheet were so drawn as to give a valuation of the company's interest in the mine as such, it might be right to accept that valuation as correct in the absence of other evidence, even if a very low figure were shown. My difficulty is that on the face of the accounts it appears that the company must have an asset, the mine, which can produce profits and is presumably of some value, but which has not been valued in the accounts at all. No doubt it may be good conservative accounting practice for a mining company to refuse to value its mine in a balance sheet at anything more than the amount spent on development thereof less depletion; but, if this practice is adopted, the balance sheet will be of no service to establish an overall capital deficiency in any sense which. would bind a third party such as the respondent. As between the board and shareholders eager for dividends, these accounts would fully justify the board in paying no dividend for 1950, but they do not in my view establish an overall capital deficiency such as should or might influence the conduct of the respondent. The learned Judge below spoke of the possibility of hidden reserves. I prefer to say that there is a patent omission to value the company's principal asset, which makes the balance sheet valueless for the purpose of estimating the -company's' true capital position.

The learned trial Judge said in his judgment: —

"I can find no ground for holding that the balance sheet of the company for 1950 shows an overall deficiency of capital. That being so, it becomes unnecessary for the purpose of deciding this appeal to construe the meaning of 'losses' in section 21".

With the first sentence of this passage I respectfully agree, but the appellant contends that the second sentence is based on a misapprehension, since, even if nooverall capital deficiency is established, the Commissioner ought to have been satisfied that "having regard to losses previously incurred by the company or tothe smallness of the profits made the payment of a dividend ... would be unreasonable." This contention was clearly raised in the court below and it certainly appears at first sight that the learned Judge either misunderstood it, or failed todeal with it.

Counsel for the appellant puts the matter in this way. Section 21 is not a. charging section and deals with a special mischief, namely, that if a company persistently refrains from distributing its profits and then is wound up, its shareholders will receive those profits in the form of a capital gain and no further tax will be payable thereon beyond that already paid by the company. He citessection 245 of the English Income Tax Act, 1952, where this is specifically stated. Certainly it must be accepted that that was the general purpose of the section. Counsel then argues that the power to make an order under section 21 is entirely discretionary, and that before such an order can properly be made it must: appear, not only that the company has had a taxable income for the relevant period of which under 60 per cent has been distributed, which is a condition precedent to the general application of the section, but also that in the commercial sense there are available profits out of which a dividend ought to bedeclared. This depends on the further contention that "losses previously incurred" may include capital losses and that "profits made" is to be interpreted according. to commercial practice and not according to income tax rules. Applying thoseprinciples to this case, it is contended that, although the profit and loss account for 1950 shows a net profit of Sh. 1,081,630/78 carried down to appropriation account, the appropriation account shows that it would be quite unreasonableto expect the company to pay any dividend at all. If the principles are correct. I think the conclusion drawn from them on the special facts could hardly be: challenged.

The respondent, however, attacks the principles themselves. He submits that: the words "losses" and "profits" in this context must bear the same meaning asthey do in every other part of the Ordinance, in other words, that losses are strictly confined to revenue losses, and losses and profits alike must be such asare ascertained in accordance with income tax law. Any other construction, he says, would lead to impossible confusion, because a dozen sets of accounts may be drawn up on the same facts without commercial impropriety, and each may show a different "profit". He further contends that, if capital losses must<br>be taken into account, then capital profits should equally be taken into account, a position which, he suggests, no taxpayer would welcome.

I think a number of objections may be taken to this argument. In the first. place there is some direct authority from India against it. In Sir Kasturchand Ltd.. v. C. I. T., Bombay (1949) 17 I. T. R. 493, at page 497, the Bombay High Court in construing section 23A of the Indian Income Tax Act, 1922, which for this purpose is in pari materia with the relevant part of section 21 of the Ordinance, held that the Income Tax Officer must consider "the smallness of the profit made by" the company in contra-distinction to the assessable income of the company ... not the assessable income of the company but the actual profits made by the company" and added,

"It is hardly necessary to emphasize the very great distinction that may" exist between the assessable income of the company and the actual accounting profits made by the company, and what the Income Tax Officer has got: to consider is the actual accounting profits made by the company and not the profits assessed to income tax or super tax by the Income Tax Officer."

This certainly supports one side of the appellant's argument. Again, if the respondent's construction is right, the only difference between "profits" and "total income" would presumably depend on exemptions under Part IV of the Ordinance. In either case the total income or profits would have been diminished by any deduction in respect of revenue losses in previous years. It is, I think, important to note that that was in fact done in this case. The income of the company for 1950 for income tax purposes would have been £47,511, but was reduced by income tax losses for 1945, 1946 and 1947 less income tax profits for 1948 and 1949, to £38,160. If "losses previously incurred" bears the limited meaning for which the respondent contends, those losses have already been allowed for in arriving at the total income for the year under consideration and it is difficult to see why the Commissioner should pay any further attention to them in deciding whether to make an order. In the same way, if "profits" has the sense submitted, the direction that the Commissioner shall have regard to the "smallness of the profits made" becomes merely a direction to ignore cases not involving substantial sums of money. Counsel sought to meet these objections by saying that a company might deserve consideration if its results fluctuated violently; but added that the appellant's case had never been put forward on that footing, and that the order ought not to be disturbed now on that narrow ground alone. With this last submission I agree. I should not wish, in view of the substantial issues put forward, to decide this appeal on that somewhat tenuous ground.

The respondent next argued that the provisions of Part III of the Second Schedule—Deductions in respect of Mining Operations—show that there is no need for the Commissioner to take into account capital expenditure on development which has been proved to be of no value, since the allowances made under that part in effect provide for that situation. The allowances actually made in this case increased gradually from about £14,000 in 1939 to about £23,000 in 1950, and it is stressed that in some unprosperous year the allowance for income tax substantially exceeded the amounts of development expenditure written off by the company in its own accounts. However, over the 12 years the company has written off rather more than it has been allowed—some £240,000 : against $£218,000$ . This provision for allowances for depletion is certainly a factor to be borne in mind. If the Commissioner is allowed to consider capital losses at all, he will no doubt keep in mind the capital allowances and the invariable problem that mines suffer depletion and have a limited life; but I do not think the provisions of Part III can themselves provide an answer to the general question of construction.

I derive little help from English law. Section 245 of the 1952 Act is very different from section 21 of the Ordinance, but the provisions of section 246 have at least this importance, that in England, where the ultimate mischief is the same as in Tanganyika, it is thought right that the Commissioners should examine the "current requirements of the company's business" and also requirements "for the maintenance and development of that busniess", and may, with certain specified exceptions, consider the whole capital position of the company. See also Montague Burton Ltd. v. C. I. R. 20 T. C. 48 at 68-9. This is no direct authority for the construction of section 21, but I think it has just this importance, that where a section deals with these particular problems there is no reason to be surprised if it departs from ordinary income tax rules and methods and requires the Commissioner to consider the position of the company from a commercial point of view. On the best consideration I can give to the question, I think that it is the true effect of section 21. I do not mean, of course, that the Commissioner is absolutely bound by the accounts put forward by the directors. He might in any case say, "This provision is not a matter<br>of prudent or cautious commercial accounting, but a mere concealment of profits which should be distributed". That, however, should be the exceptional

case, and unless it arises I think the Commissioner's approach to the matter should be to consider the accounts put before him as a prudent business man would, and if on the whole he is of opinion that on that footing the board could not fairly be expected to pay a dividend, he should not make an order under section $21$ .

If I am right, I think it is clear that the High Court at least has not considered the matter on the correct footing, and, although we have no means of knowing the reasoning on which the Commissioner or the local committee based their respective decisions, I do not think it would be disputed that their approach to the question was based on the view of the law which the respondent has put forward to us, and which is in my opinion an incorrect view. It is therefore necessary that the matter should be re-examined with a view to a decision based on different principles. I have felt some doubt whether it would be sufficient to remit the matter to the High Court, which in most income tax matters has the wide powers of a court of first instance, but I think this is rather a special case. Section 21 vests a special discretion in the Commissioner. He has exercised it in this case, as I think, on wrong principles. The present Order was wrongly made and the assessment based on it should be quashed; but heremains the proper person to exercise that discretion, and it is not for us to say that in this case he could not possibly make an order in accordance with the principles which we have laid down. I think the matter should be remitted tohim with a direction that the existing order was unlawfully made and must betreated as a nullity. In consequence it is open to him to reconsider the wholematter and to take such steps as may be proper. I think this appeal must be allowed. The respondent should pay the appellant's costs of this appeal and of the appeal to the High Court.

SIR BARCLAY NIHILL (President).—I concur in the judgment prepared bythe learned Justice of Appeal and have nothing to add. An order will be madein the terms he has proposed.

SIR NEWNHAM WORLEY (Vice-President).—I have had the advantage of reading the judgment prepared by the learned Justice of Appeal. I agree with it and have nothing to add.