Inland Revenue Comrs v Westminster (Duke)

A taxpayer may arrange genuine legal transactions so that less tax becomes payable. Tax liability depends on the legal rights and obligations actually created, construed as a whole and in their surrounding circumstances. A court cannot replace those rights with a different transaction based on a broad view of economic substance or statutory purpose.

An unconditional annual payment does not become remuneration merely because its recipient remains employed by the payer and accepts reduced wages. The payment retains its legal character where it remains payable independently of employment. Documents which are not bona fide, and merely conceal another transaction, may nevertheless be disregarded.

The respondent executed seven-year deeds covenanting to make weekly payments to employees. The deeds stated that the payments recognised past service, remained payable irrespective of future work and were without prejudice to remuneration for future services. Most employees also acknowledged letters expressing an expectation that, while employed, they would accept only enough additional money to maintain their former total pay. Mr Blow received a deed without such a letter.

The General Commissioners and Finlay J treated the payments made while employment continued as remuneration and therefore non-deductible in computing the respondent's income for surtax. The Court of Appeal reversed that decision. The Commissioners appealed to the House of Lords. The central issue was whether the covenanted sums were remuneration within Schedule E or deductible annual payments within Schedule D.

1. Appeal dismissed by a majority of four to one. Lord Tomlin, Lord Russell of Killowen, Lord Macmillan and Lord Wright held that the covenanted sums remained annual payments deductible in computing the respondent's total income for surtax. The Court of Appeal's order was affirmed, with the appellants ordered to pay the respondent's appeal costs.

2. Per Lord Tomlin, Lord Russell, Lord Macmillan and Lord Wright, the deeds created genuine and unconditional obligations to make the stipulated payments whether or not the recipients continued in employment. The sums therefore fell within Schedule D rather than Schedule E. Their legal character did not change merely because an employee continued working and, in practice, received an additional sum bringing the total payment to the former wage.

3. Per Lord Tomlin, Lord Russell and Lord Wright, the letters and acknowledgments did not convert the covenanted sums into wages. Lord Tomlin, Lord Russell and Lord Wright considered that the language expressed an expectation rather than an enforceable promise to treat the annuity as remuneration. Lord Macmillan considered that the documents embodied a binding collateral agreement to accept reduced remuneration, but held that this did not alter the independent obligation created by the deed.

4. Per Lord Tomlin, with materially similar reasoning from Lord Russell and Lord Wright, the substance of a transaction for tax purposes is found by ascertaining the parties' legal rights and obligations under ordinary legal principles. A court cannot disregard genuine instruments and substitute different rights because the resulting arrangement reduces tax. A person may lawfully order his affairs so that the tax imposed by the applicable legislation is less.

5. Per Lord Tomlin and Lord Wright, documents which are not bona fide or are intended merely as a cloak for another transaction may be disregarded. That qualification did not apply because the deeds were admittedly genuine and operated according to their terms.

6. Lord Atkin dissented as to the employees who signed letters and acknowledgments. He construed those documents as contracts under which the deed payments satisfied part of the existing wage obligation and would therefore have allowed the appeal in those cases. He agreed that Mr Blow's payment, for which there was no collateral letter or evidence of agreement, was deductible.

1. House of Lords: By a majority of four to one, dismissed the Commissioners' appeal and affirmed the Court of Appeal's order.
2. Court of Appeal: Set aside Finlay J's decision and gave judgment for the respondent.
3. High Court: Finlay J affirmed the General Commissioners' determination in favour of the Crown.
4. General Commissioners: Held that payments to recipients who remained employed were, in substance, remuneration for continuing service and were not deductible annual payments.